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?
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.
Get Answers For Free
Most questions answered within 1 hours.