Question

Shanks Corporation is considering a capital budgeting project that involves investing $600,000 in equipment that would have a useful life of 3 years and zero salvage value. The company would also need to invest $20,000 immediately in working capital which would be released for use elsewhere at the end of the project in 3 years. The net annual operating cash inflow, which is the difference between the incremental sales revenue and incremental cash operating expenses, would be $300,000 per year. The project would require a one-time renovation expense of $60,000 at the end of year 2. The company uses straight-line depreciation and the depreciation expense on the equipment would be $200,000 per year. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting. The income tax rate is 35%. The after-tax discount rate is 15%. Required: Determine the net present value of the project. Show your work! Essay

Answer 1

Net present value : - $ 47,168

	0	1	2	3
Cost of Equipment	$ (600,000)
Working Capital	(20,000)
EBITDA		$ 300,000	$ 300,000	$ 300,000
Depreciation		200,000	200,000	200,000
Operating Cash Flows After Taxes *		265,000	265,000	265,000
Renovation Expense			(60,000)
Working Capital Release				20,000
Net cash flows	(620,000)	265,000	205,000	285,000
PV factor at 15 % discount rate	1.0000	0.8696	0.7561	0.6575
Present Values	(620,000)	230,444	155,000.50	187,387.50
Net Present Value	$ ( 47,168)

* Operating cash flows after taxes = EBITDA x ( 1 -t) + Depreciation x t = $ 300,000 x ( 1 - 0.35) + $ 200,000 x 0.35 = $ 195,000 + $ 70,000 = $ 265,000.