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!

Answer #1

**Calculation of Net Present value of the
project:**

Year | Net annual operating cash flow | Depreciation | One time renovation | Profit (PBT) | Tax | Profit after tax | Depreciation | Cash inflow |

1 | 300000 | 200000 | - | 100000 | 35000 | 65000 | 200000 | 265000 |

2 | 300000 | 200000 | 60000 | 40000 | 14000 | 26000 | 200000 | 226000 |

3 | 300000 | 200000 | - | 100000 | 35000 | 65000 | 200000 | 265000 |

**Initial cash outflow:**

Cost of equipment = $600000

Working capital = $20000

**Total -A = $620000**

**Operating cash inflows:**

Year 1: 265000*0.8696 = $230444

Year 2: 226000*0.7561 = $170879

Year 3 : 265000*0.6575 = $174237

**Total -B = $ 575560**

**End of 3 years; Release of working capital**

Year 3 : 20000*0.6575 (**C)** = $ 13150

**Net Present value = B-A+C =
575560-620000+13150**

**= -31290.**

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....

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