Question

Quad Enterprises is considering a new 3-year expansion project that requires an initial fixed asset investment of $1.134 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of $88,200. The project requires an initial investment in net working capital of $126,000. The project is estimated to generate $1,008,000 in annual sales, with costs of $403,200. The tax rate is 22 percent and the required return on the project is 16 percent. What is the project's Year 0 net cash flow? What is the project's Year 1 net cash flow? What is the project's Year 2 net cash flow? What is the project's Year 3 net cash flow? What is the NPV?

Answer 1

Year 0 cash flow = Cost + NWC

Year 0 cash flow = -1,134,000 - 126,000

Year 0 cash flow = -1,260,000

Annual depreciation = 1,134,000 / 3 = 378,000

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

Year 1 cash flow = (1,008,000 - 403,200 - 378,000)(1 - 0.22) + 378,000

Year 1 cash flow = 176,904 + 378,000

Year 1 cash flow = $554,904

Year 2 cash flow = $554,904

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

Year 3 non operating cash flow = 88,200 + 126,000 - 0.22(88,200 - 0)

Year 3 non operating cash flow = 88,200 + 126,000 - 19,404

Year 3 non operating cash flow = 194,796

Year 3 cash flow = $554,904 + $194,796

Year 3 cash flow = $749,700

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

NPV = -1,260,000 + 554,904 / (1 + 0.16)¹ + 554,904 / (1 + 0.16)² + 749,700 / (1 + 0.16)³

NPV = $111,050.64