Question

P10-20 (similar to) Question Help Project cash flow and NPV. The managers of Classic Autos Incorporated plan to manufacture classic Thunderbirds (1957 replicas). The necessary foundry equipment will cost a total of $4,500,000 and will be depreciated using a five-year MACRS life. The sales manager has an estimate for the sale of the classic Thunderbirds. The annual sales volume will be as follows: Year one: 230 Year two: 300 Year three: 360 Year four: 370 Year five: 330 If the sales price is $26,000 per car, variable costs are $16,000 per car, and fixed costs are $1,100,000 annually, what is the annual operating cash flow if the tax rate is 30%? The equipment is sold for salvage for $500,000 at the end of year five. Net working capital increases by $500,000 at the beginning of the project (year ) and is reduced back to its original level in the final year. Find the internal rate of return for the project using the incremental cash flows. First, what is the annual operating cash flow of the project for year 1? $ (Round to the nearest dollar.)

Answer 1

Depreciation of the Foundry Equipment will be as follows, using the 5 years MACRS depreciation schedule

Depreciation using MACRS 5 year life
Year	Depreciation calculation	Amount
Year 1	=4500000*0.2	900000
Year 2	=4500000*0.32	1440000
Year 3	=4500000*0.192	864000
Year 4	=4500000*0.1152	518400
Year 5	=4500000*0.1152	518400

Year	Sales Price per car	Units Sold	Sales Calculation	Sales Amount (in $)	Variable Costs or COGS per car	Variable costs or COGS Calculation	COGS Amount (in $)
Year 1	26000	230	=26000*230	59,80,000	16000	=16000*230	36,80,000
Year 2	26000	300	=26000*300	78,00,000	16000	=16000*230	48,00,000
Year 3	26000	360	=26000*360	93,60,000	16000	=16000*230	57,60,000
Year 4	26000	370	=26000*370	96,20,000	16000	=16000*230	59,20,000
Year 5	26000	330	=26000*330	85,80,000	16000	=16000*230	52,80,000

			All amounts in US $, in thousands (rounded)
			Year 1	Year 2	Year 3	Year 4	Year 5
Sales Revenue			5,980	7,800	9,360	9,620	8,580
Less : COGS			3,680	4,800	5,760	5,920	5,280
Less : Fixed Cost			1,100	1,100	1,100	1,100	1,100
Less : Depreciation			900	1,440	864	518	518
EBIT			300	460	1,636	2,082	1,682
Less : Taxes @30%			90	138	491	624	504
Net Income			210	322	1,145	1,457	1,177
Add : Depreciation			900	1,440	864	518	518
Operating Cash flows			1,110	1,762	2,009	1,976	1,696

Hence, the operating cash flows for first year are $1,100,000.

Now to calculate the NPV, we need to find the gain/loss on sale of equipment

Book value of the equipment after 5 years = 4,500,000- sum of depreciation for 5 years (from above table )

= $ 259200

Salvage value at the end of 5 years = $500,000

Gain on the sale of equipment = $240,800

Tax on gain on sale of equipment = 0.3*$240,800= $72,240

After tax cash flow on disposal = $500,000 - $72,240 = $427,760

The incremental cash flows have been mentioned below

			Incremental Cash Flow, in US $, in thousands (rounded)
			Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Investment			-4,500
Change in Net working capital			-500					500
Operating Cash flows				1,110	1,762	2,009	1,976	1,696
After tax salvage value								428
Total Incremental Cash Flows			-5,000	1,110	1,762	2,009	1,976	2,623

To calculate NPV, we need the discount rate, which I am assuming would be a part of the next sub question. You will need to discount it using the same discount rate to find the NPV.

Hope this helps ! :)