Question

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6. Summer Tyme, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $3.9 million. The fixed asset falls into the three-year MARCRS class and will be depreciated over its three-year tax life. The project is estimated to generate $2,650,000 in annual sales, with costs of $840,000. Suppose the project requires an initial investment in net working capital of $300,000 and the net working capital will be fully recovered at the end of the project. Also, the fixed asset will have a market value of $210,000 at the end of the project. Suppose that the tax rate is 21% and the required rate of return on the project is 12%. What are the project's NPV and IRR? Should the firm accept this project?

Answer 1

NPV	$229,468.47

IRR

15.05%

The project should be accepted since NPV is positive.

Step 1: OCF

OCF		MACRS 3 year
Year	Cash flows	Depreciation	EBIT	Tax	PAT	OCF
1	1810000	-1299870	510130	-107127.3	403002.7	1702872.7
2	1810000	-1733550	76450	-16054.5	60395.5	1793945.5
3	1810000	-577590	1232410	-258806.1	973603.9	1551193.9

Step 2: Salvage

Salvage
Purchase price	3900000
Less: Depreciation	-3611010
Closing book value	288990
Selling price	210000
Gain/(loss)	-78990
Tax/ Saving	16587.9
Net salvage	226588

Step 3: Net Cash flows

Year	Initial cash flow	OCF	Working capital	Salvage	Net cash flows
0	-3900000		-300000		-4200000
1		$1,702,872.70			1702872.7
2		$1,793,945.50			1793945.5
3		$1,551,193.90	300000	226587.9	2077781.8
				NPV	$229,468.47
				IRR	15.05%

AutoSave © of HO- Book1 - Excel Sign in - o X File Home Insert Draw Page Layout Formulas Data Review View Help O Tell me what you want to do Share Comments Calibri = = det - 8 - À À - A - E = S ab - General $ - % 9 Insert Delete - 1. Format - 2' AZ O T- Sort & Find & Filter - Select Paste B I U - Conditional Format as Formatting Table Cell Styles Clipboard Font Alignment Number Styles Cells Editing B4 - x X = fx 210000 C D E F G H 2 A B INPUTS Initial cost 3900000 Tax rate 0.21 Selling price 210000 Working capital 300000 MARR 0.12 Annual cash flow =2650000-840000 Working capital Salvage =-B5 mt Year Initial cash flow OCH 0 --B2 =117 =118 3 =119 K L Salvage Purchase price =B2 Less: Depreciation =SUM(E17:E19) Closing book value =L2+L3 Net cash flows =SUM(D3:63) SUM(D4:44) =SUM(D5:45) =SUM(D6:46) 1 5 =-F3 =L10 1 Selling price Gain/(loss) Tax/ Saving =B4 =L6-L4 =-L7*B3 600 NPV IRR =NPV(B6, H4:H6)+H3 =IRR(H3:H6) Net salvage =L6+L8 12 13 14 15 Year 16 1 17 2 18 3 19 4 20 5 21 6 22 Depreciation rate 0.3333 0.4445 0.1481 0.0741 OCF Year Cash flows 1 =$B$ 7 2 =$B$7 3 =$B$7 MACRS 3 year Depreciation EBIT Tax PAT 1 =$D$3*B16 =SUMD17:E17) |--F17*$B$3 =F17+G17 =$D$3*B17 =SUM(D18:E18) =-F18*$B$3 =F18+G18 =$D$3*B18 =SUM(D19:E19) |--F19*$B$3 |=F19+G19 OCE =H17-E17 =H18-E18 =H19-E19