Question

Quad Enterprises is considering a new 3-year expansion project that requires an initial fixed asset investment of $1.296 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of $100,800. The project requires an initial investment in net working capital of $144,000. The project is estimated to generate $1,152,000 in annual sales, with costs of $460,800. The tax rate is 25 percent and the required return on the project is 12 percent.

  

What is the project's Year 0 net cash flow?

  

What is the project's Year 1 net cash flow?

  

What is the project's Year 2 net cash flow?

  

What is the project's Year 3 net cash flow?

  

What is the NPV?

Answer 1

We assume that the working capital will be returned after the 3rd year. Since it is straight-line depreciation, the depreciation for each year will be = 1.296/3 = $0.432 million. Hence, the zero year cash flow will be = -144,000. The first-year cash flow will be = (1,152,000 - 460,800 - 432,000) x (1 - 0.25) = 194,400. Similarly, the second year cash flow will be = (1,152,000 - 460,800 - 432,000) x (1 - 0.25) = 194,400. The third year cash flow will be = (1,152,000 - 460,800 - 432,000 + 144,000) x (1 - 0.25) = 302,400.

The NPV equation will be:

NPV = -144000 + 194400/1.12 + 194400/1.12^2 + 302400/1.12^3 = 399788.3