Question

You consider undertaking the R&D project. The initial cost of investment in new equipment is $800K....

You consider undertaking the R&D project. The initial cost of investment in new equipment is $800K. It will increase sales by $200K per year starting next year and its life is twenty years. The maintenance cost is $100K and the depreciation is 40K (1/20 of $800K). The tax rate is 40% and there are no changes in net operating working capital.

What are the cash flows of the investment project?

Would you expand if the cost of capital (WACC) is 10%?

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Answer #1

Casf outflow at year 0 = 800,000

Operating cash flow from year 1 through year 20 = ( Sales - costs - depreciation)( 1 - tax) + depreciation

Operating cash flow from year 1 through year 20 = ( 200,000 - 100,000 - 40,000)( 1 - 0.4) + 40,000

Operating cash flow from year 1 through year 20 = 36,000 + 40,000

Operating cash flow from year 1 through year 20 = 76,000

NPV = Annuity * [ 1 - 1 / ( 1 + R)n] / R - initial invetment

NPV = 76,000 * [ 1 - 1 / ( 1 + 0.1)20] / 0.1 - 800,000

NPV = 76,000 * 8.513564 - 800,000

NPV = -$152,969.16

We should NOT expand as it has a negative NPV.

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