Question

Down Under Boomerang, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $2.28 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which it will be worthless. The project is estimated to generate $1,750,000 in annual sales, with costs of $660,000. The tax rate is 23 percent and the required return is 13 percent. What is the project’s NPV?

Answer 1

Annual depreciation=(Cost-Salvage value)/Useful Life

=(2,280,000/3)=$760,000/year

Hence annual operating cash flow=(Sales-Costs)(1-tax rate)+Tax savings on Annual depreciation

=(1,750,000-660,000)(1-0.23)+(0.23*760,000)

=$1,014,100

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=$1,014,100[1-(1.13)^-3]/0.13

=$1,014,100*2.361152598

=$2,394,444.85

NPV=Present value of inflows-Present value of outflows

=$2,394,444.85-$2,280,000

=$114,444.85(Approx).