Question

Firm X has the opportunity to invest $287,000 in a new venture. The projected cash flows...

Firm X has the opportunity to invest $287,000 in a new venture. The projected cash flows from the venture are as follows. Use Appendix A and Appendix B.

Year 0 Year 1 Year 2 Year 3
Initial investment $ (287,000 )
Revenues $ 55,400 $ 55,400 $ 55,400
Expenses (33,240 ) (8,310 ) (8,310 )
Return of investment 287,000
Before-tax net cash flow (287,000 ) $ 22,160 $ 47,090 $ 334,090

Firm X uses an 8 percent discount rate, and its marginal tax rate over the life of the venture will be 30 percent. Required:

a-1. Complete the below table to calculate NPV. Assume that the revenues are taxable income, and the expenses are deductible.

a-2. Should firm X make the investment?

b-1. Complete the below table to calculate NPV. Assume that the revenues are taxable income, but the expenses are nondeductible.

b-2. Should firm X make the investment?

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Answer #1

Calculation of NPV -

Present Value of Cash inflow - Present Value of Cash Outflow

Decision Making -

If, NPV > 0 it means investment can be made.

If, NPV<0 it means inverstment cannot be made.

Reason - We need to compare the present value of the cash inflows generated over the period of time with the intial investment.

If the NPV is greater than 0 it implies that present value of the future cash inflows is more than the current outflow. Thus, investment is viable.

If the NPV is less than 0 it implies that present value of the future cash inflows is not more than the current outflow. Thus, investment is not viable.

a-1 Complete the below table to calculate NPV. Assume that the revenues are taxable income, and the expenses are deductible.

Year Net Present Value
Initial Investment Revenues Expenses Before Tax cashflow Tax@30% Return of Investment After tax cashflow PVF@8% PV
0 (287,000.00)                         -                                  -                                  -                                  -                                  -   (287,000.00) 1.0000    (287,000.00)
1                       -           55,400.00               (33,240.00)                 22,160.00                 (6,648.00)                                -          15,512.00 0.9259        14,362.96
2                       -           55,400.00                 (8,310.00)                 47,090.00               (14,127.00)                                -          32,963.00 0.8573        28,260.46
3                       -           55,400.00                 (8,310.00)                 47,090.00               (14,127.00)                                -          32,963.00 0.7938        26,167.09
3                       -                           -                                  -                                  -                                  -                 287,000.00      287,000.00 0.7938      227,829.85
NPV           9,620.37

a-2. Should firm X make the investment?

Yes, Firm X can make the investment as NPV is greater than 0 which implies that the present value of the future cash inflows are more than the current outflows.

b-1. Complete the below table to calculate NPV. Assume that the revenues are taxable income, but the expenses are nondeductible.

Year Net Present Value
Initial Investment Revenues Expenses Tax@30% Return of Investment After tax cashflow PVF@8% PV
0 (287,000.00)                         -                                  -                                  -                                  -              (287,000.00) 1.0000      (287,000.00)
1                       -           55,400.00               (33,240.00)               (16,620.00)                                -                     5,540.00 0.9259 5,129.63
2                       -           55,400.00                 (8,310.00)               (16,620.00)                                -                   30,470.00 0.8573          26,123.11
3                       -           55,400.00                 (8,310.00)               (16,620.00)                                -                   30,470.00 0.7938          24,188.07
3                       -                           -                                  -                                  -                 287,000.00               287,000.00 0.7938        227,829.85
NPV          (3,729.33)

b-2. Should firm X make the investment?

No, Firm X should not make the investment as NPV is less than 0 which implies that the present value of the future cash inflows are not more than the current outflows.

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