Question

snowbowl Resorts wants to create more snowmaking capacity on their ski mountain. This increase in capacity requires the purchase of additional snow-making equipment that will cost $657,000. Based on input from the Accounting Department, this would be depreciated on a straight-line basis to zero over the 5-year life of this new snowmaking project. When the project is over, the equipment can be sold for $172,000. There is a need for additional net working capital at the beginning of the project in the amount of $42,000. This will be recovered at the end of the project. The operating cash flow will be $153,400 a year. Assume the appropriate discount rate is 10 percent and that the appropriate tax rate is 35 percent.  What is the net present value of this snowmaking project?

Answer 1

Annual depreciation of equipment = Purchasing cost/Number of useful years

                                                       = $ 657,000 /5 = $ 131,400

Computation of annual cash flow:

Operating cash flow	$153,400
Less: Depreciation	$131,400
Profit before tax	$22,000
Tax @ 35 %	$7,700
Net profit	$14,300
Add: Depreciation	$131,400
Net annual cash flow	$145,700

Cash flow in year 0 = Purchasing cost of equipment + Working capital

                                = $ 657,000 + $ 42,000 = $ 699,000

Cash flow in year 5 = Net annual cash flow + Salvage value x (1-Tax rate) + Working capital release

                                  = $ 145,700 + $ 172,000 (1- 0.35) + $ 42,000

                                 = $ 145,700 + ($ 172,000 x 0.65) + $ 42,000

                                = $ 145,700 + $ 111,800 + $ 42,000

                                = $ 299,500

NPV = PV of future cash inflow – Initial investment

Year	Cash Flow (C)	Computation of PV Factor	PV Factor @ 10 % (F)	PV (C x F)
0	-$699,000	1/ (1+0.1)0	1	-$699,000.00
1	$145,700	1/ (1+0.1)1	0.909090909090909	$132,454.55
2	$145,700	1/ (1+0.1)2	0.826446280991735	$120,413.22
3	$145,700	1/ (1+0.1)3	0.751314800901578	$109,466.57
4	$145,700	1/ (1+0.1)4	0.683013455365071	$99,515.06
5	$299,500	1/ (1+0.1)5	0.620921323059155	$185,965.94
			NPV	-$51,184.67

NPV of the project is - $ 51,184.67