Question

Calculate the NPV for the following capital budgeting proposal: $1,100,000 initial cost for equipment, $5,000 pre-tax salvage value of equipment, 35% tax rate, $45,000 additional annual revenues, $15,000 additional annual cash expenses, $8,000 initial investment in working capital to be recouped at project end, project ends in year 5, and a cost of capital of 10%. Should the project be accepted or rejected? (Show your work computing the NPV.)

Answer 1

The initial cost of the project is : ($1,100,000) + ($8000) [ cost of equipment + working capital expenditure]

The cash flows of the project are :

($45,000 - $15,000) * 0.65 for years 1 to year 4

= $19,500

The cash flow for year 5 is:the cash flows + after tax salvage value + woking capital recovery

= $19,500 +$ 5000* 0.65 + $8000

=$30,750

So, the NPV of the project is :

CFO = ($11,08,000)

CF1 = $19,500

CF2 = $19,500

CF3= $19,500

CF4 = $19,500

CF5= $30,750

I/Y = 10%

NPV = - $1,027,094.293

No, the project should be rejected. As accepting this project will lead to wealth destruction.