Question

Thurston Petroleum is considering a new project that complements its existing business. The machine required for the project costs $5.1 million. The marketing department predicts that sales related to the project will be $3.15 million per year for the next four years, after which the market will cease to exist. The machine will be depreciated to zero over its 4-year economic life using the straight-line method and have a salvage value of 0. Cost of goods sold and operating expenses related to the project are predicted to be 30 percent of sales. The company also needs to add net working capital of $250,000 immediately. The additional net working capital will be recovered in full at the end of the project’s life. The tax rate is 25 percent and the required return for the project is 13 percent.

  

What is the value of the NPV for this project? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)

Answer 1

The initial investment in the project is : $5,10,0000

working capital investment = $25,0000

total cash flows in year 0 = $5,35,0000

the total sales are = $3,15,0000

cost of goods sold : $9,45,000

gross profit : $22,05,000

depreciation = $5,10,0000/4 = $1,27,5000

So, cash flow = sales - cogs + depreciation*tax

= $22,05,000(1-0.25) + 12,75,000*0.25

= 1653750 + $318750

= $1,972,500

The cash flows will continue from year 1 to year 3

The terminal cash flow : $1,972,500 + $250,000 ( working capital investment is recovered)

= $2,222,500.

So,

CF0 = ($5,35,0000)

CF1 = $1,9725,00 THIS WILL CONTINUE TILL CF3

CF4 = $1,9725,00 + $250,000 = $2,222,500

I/Y =13%

The NPV is $6,70,474.37 ( rounded off to two decimal places)