Question

Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.32 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $1.735 million in annual sales, with costs of $650,000. The project requires an initial investment in net working capital of $250,000, and the fixed asset will have a market value of $180,000 at the end of the project. The tax rate is 21 percent.

a. What is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (Do not round intermediate calculations. Enter your answers in dollars, not millions of dollars, e.g., 1,234,567. A negative answer should be indicated by a minus sign.)

b. If the required return is 12 percent, what is the project's NPV? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Year 0=

Year 1=

Year 2=

Year 3=

NPV=

Answer 1

a)

Year 0 cash flow = Initial investment + increase in NWC

Year 0 cash flow = -2,320,000 - 250,000

Year 0 cash flow = -2,570,000

b)

Annual depreciation = 2,320,000 / 3 = 773,333.3333

year 1 cash flow = (Sales - costs - depreciation)(1 - tax) + depreciation

year 1 cash flow = (1,735,000 - 650,000 - 773,333.3333)(1 - 0.21) + 773,333.3333

Year 1 cash flow = 246,216.6667 + 773,333.3333

Year 1 cash flow = $1,019,550

c)

Year 2 cash flow = $1,019,550

d)

Year 3 non operating cash flow = Market value + recovery of NWC - tax(market value - book value)

Year 3 non operating cash flow = 180,000 + 250,000 - 0.21(180,000 - 0)

Year 3 non operating cash flow = 180,000 + 250,000 - 37,800

Year 3 non operating cash flow = $392,200

Year 3 cash flow = 392,200 + 1,019,550

Year 3 cash flow = $1,411,750

2)

NPV = Present value of cash inflows - present value of cash outflows

NPV = -2,570,000 + 1,019,550 / (1 + 0.12)^1 + 1,019,550 / (1 + 0.12)^2 + 1,411,750 / (1 + 0.12)^3

NPV = $157,947.28