Question

PADICO is considering an investment project. The project requires an initial $5 million outlay for equipment and machinery. Sales are projected to be $2.5 million per year for the next four years. The equipment will be fully depreciated straight-line by the end of year 4. The cost of goods sold and operating expenses (not including depreciation) are predicted to be 30% of sales. The equipment can be sold for $500,000 at the end of year 4.Padico also needs to add net working capital of $100,000 immediately. The networking capital will be recovered in full at the end of the fourth year. Assume the tax rate is 40% and the cost of capital is 12%.

A-what is the initial investment

B-what is the OCF

C-what is the terminal value

D-What is the NPV of this investment?

I NEED TO SEE EACH STEP SOLUTION WRITING THE ANSWER ONLY IS CONSIDERED WRONG

Answer #1

A). Initial cash flow (CF0) = initial investment + increase in NWC = 5,000,000 + 100,000 = 5,100,000

B). Operating cash flow (OCF) = (revenue - expense)*(1-Tax rate) + (depreciation*Tax rate)

Revenue = 2,500,000; expense = 30%*revenue = 30%*2,500,000 = 750,000

Depreciation = initial investment/4 = 5,000,000/4 = 1,250,000

OCF = (2,500,000-750,000)*(1-40%) + (1,250,000*40%) = 1,550,000

Cash flow from Year 1 to Year 3 = OCF per year = 1,550,000

C). Terminal value = return of NWC + after-tax salvage value

= 100,000 + 500,000*(1-40%) = 400,000

D). Cash flow (CF4) in Year 6 = OCF +

= 1,550,000 + 400,000 = 1,950,000

So, total cash flows for the project are:

CF0 = -5,100,000; CF1 = 1,550,000; CF2 = 1,550,000; CF3 = 1,550,000; CF4 = 1,950,000

NPV = sum of discounted cash flows

= -5,100,000 + 1,550,000/(1+12%) + 1,550,000/(1+12%)^2 + 1,550,000/(1+12%)^3 + 1,950,000/(1+12%)^4 = -137,901.28

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