Question

Yummy Foods is considering a new salsa product whose data are shown below. The equipment that would be used has a 3-year tax life and would be depreciated by the straight line method over the project's 3-year life. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? (Please be sure to show your calculations and how you got to the answer).

                  Hurdle Rate/WACC 10%

                  Net initial investment                                                  $60,000

                  Initial increase in NOWC                                            $10,000

                  Salvage value                                                              $10,000

                  Sales revenues                                                             $70,000

                  Operating costs excluding depreciation                    $30,000

                  Tax rate                                                                             40%

Answer 1

Answer:

Year 0 cash outflow:

Year 0 cash outflow = Net initial investment + increase in NOWC = 60000 + 10000 = $70,000

Year 1 and Year 2 Operating cash flow:

Annual depreciation = 60000 / 3 = $20,000

Operating cash flow = (Sales revenues - Operating costs excluding depreciation) * (1 - Tax rate) + Depreciation tax shield

= (70000 - 30000) * (1 - 40%) + 20000 * 40%

= 24000 + 8000

= $32,000

Terminal cash flow at the of year 2 :

Terminal cash flow = After tax salvage value + Recovery of NOWC

= 10000 * (1 - 40%) + 10000

= $16,000

NPV:

NPV = 32000 / (1 + 10%) + (32000 + 16000) / (1 + 10%)^2 - 70000

= -$1239.66 or ($1239.66)

NPV = ($1239.66)