Question

Down Under Boomerang, Inc. is considering a new three-year expansion project that requires an initial fixed asset investment of $1.65 million. The fixed asset will be depreciated straight=line to zero over its three-year tax life, after which it will be worthless. The project is estimated to generate $1.24 million in annual sales, with costs of $485,000. The tax rate is 35% and the required rate of return in 12%. What is the project's NPV?

*** I NEED SOME HELP WITH THE PRESENT VALUE OF FUTURE CASH FLOWS FORMULA. I CANNOT FIGURE IT OUT!! THANK YOU!

Answer 1

Depreciation per year = $1,650,000 / 3 = $550,000

Tax shield of depreciation per year = $550,000 x 35% = $192,500

Operating profits net of tax (excluding depreciation) = (sales - costs) x (1 - tax rate) = ($1,240,000 - $485,000) x (1 - 0.35) = $490,750

Cash inflows per year = $490,750 + $192,500 = $683,250

NPV = (-)Initial investment + Cash inflows per year x PVIFA (12%, 3)

or, NPV = (-)$1,650,000 + $683,250 x 2.40183126819

or, NPV = (-)$8,948.78601 or $8,948.79

PVIFA is present value of interest factor annuity and is computed as follows -

, where r = required return = 0.12 , n = no. of years = 3