Your company, Dominant Retailer, Inc., is considering a project whose data are shown below. Revenue and cash operating expenses are expected to be constant over the project's 5 year expected operating life; annual sales revenue is $99,000.00 and cash operating expenses are $49,750.00. The new equipment's cost and depreciable basis is $155,000.00 and it will be depreciated by MACRS as 5 year property. The new equipment replaces older equipment that is fully depreciated but can be sold for $7,000. In addition, the new equipment requires an additional $5,000 of net operating working capital, which can be fully recovered at the end of the project. The new equipment is expected to be sold for $10,750 at the end of the project in year 5. The marginal tax rate is 20.00%. What is the project's Initial Cash Outlay at Year 0? Note: Enter your answer rounded off to two decimal points. Do not enter $ or comma in the answer box. For example, if your answer is $12,300.456 then enter as 12300.46 in the answer box.
2.Using the information from problem 2 on Dominant Retailer, Inc., what is the NPV of the Project if Dominant Retailer’s WACC is 12.75%? Enter your answer rounded to two decimal places. Do not enter $ or comma in the answer box. For example, if your answer is $12,300.456 then enter as 12300.46 in the answer box.
3.Using the information from problem 2 on Dominant Retailer, Inc., what is the Year 2 Net Operating Cash Flow? Enter your answer rounded to two decimal places. Do not enter $ or comma in the answer box. For example, if your answer is $12,300.456 then enter as 12300.46 in the answer box.
Answer :
(1.) Calculation of project's Initial Cash Outlay at Year 0
Year 0 cash outflow = New equipment cost - Old equipment sale value net of tax + net operating working capital
Year 0 cash outlay = 155000 - ( 7000 * 0.80 ) + 5000
Year 0 cash outlay = 155000 - 5600 + 5000
Year 0 cash outlay = 154400
(2.) NPV of the Project if Dominant Retailer’s WACC is 12.75%
Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
Initial Investment ( 80000 + 40000) | 155000 | |||||
Annual Sales Revenue | 99000 | 99000 | 99000 | 99000 | 99000 | |
Cash Operating Cost | 49750 | 49750 | 49750 | 49750 | 49750 | |
Less : Depreciation (Working Note) | 31000 | 49600 | 29760 | 17856 | 17856 | |
Earning before taxes | 18250 | -350 | 19490 | 31394 | 31394 | |
Taxes @ 20% | -3650 | 70 | -3898 | -6278.8 | -6278.8 | |
Earnings After Taxes | 14600 | -280 | 15592 | 25115.2 | 25115.2 | |
Add : Depreciation | 31000 | 49600 | 29760 | 17856 | 17856 | |
Plus : Salvage Value | 10750 | |||||
Less : tax on salvage @ 20% | 364.4 | |||||
Sale Value of Old Machine ( Net of Taxes) | -5600 | |||||
NWC | 5000 | |||||
Plus : Recapture of NWC | 5000 | |||||
Operating Cash Flows | 154400 | 45600 | 49320 | 45352 | 42971.2 | 58356.8 |
PV Factor @ 12.75% | 1 | 0.88691796 | 0.786623468 | 0.697670482 | 0.61877648 | 0.548803974 |
PV of Net Cash flows (Inflow) | 40443.45898 | 38796.26944 | 31640.75168 | 26589.56789 | 32026.44373 | |
PV of Net Cash flows (Outflow) | 154400 | |||||
The net present value (NPV) of this project is | = $ 15096.4917 or $ 15096.49 | |||||
NPV = PV of cash inflow - PV of cash outflow | ||||||
= 169496.4917- 154400 | ||||||
= $ 15096.4917 or $ 15096.49 | ||||||
Working Note : | ||||||
Year 1 : 155000 * 20% = 31000 | ||||||
Year 2 : 155000 * 32% = 49600 | ||||||
Year 3 : 155000 * 19.2% = 29760 | ||||||
Year 4 : 155000 * 11.52% = 17856 | ||||||
Year 5 : 155000 * 11.52% = 17856 | ||||||
Book Value = 155000 * 5.76% = 8928 | ||||||
Gain on Sale = Salvage Value - Book Value | ||||||
= 10750 - 8928 | ||||||
= 1822 | ||||||
Tax on Gain on Sale = 1822 * 0.20 = 364.4 | ||||||
(3.) Year 2 Net Operating Cash Flow as calculated in image above is 49320.
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