Question

Company ABC is considering a new 5 year project where it will invest in a new machine. The key financial data for the project are as follows: The machine will cost $1,250,000. It will last for 5 years and will have no salvage value. Expected revenue per year is $650,000 and total cost per year is 300,000 (depreciation is not included) The straight line depreciation method is used to depreciate the machine The company’s tax rate is 25% What is the NPV of the project if the company’s cost of capital is 7%?

Select one: a. $82,564 b. $325,000 c. $1,332,564 d. -$942,485

ABC Company’s revenue is $140,000.

Its variable cost is $40,000

Its fixed costs is $80,000

It tax rate is 25%

Based on this information, what is its operating leverage?

Select one:

a. 5.0 b. 2.0 c. 1.75 d. 6.3

Answer 1

Solution to the FIRST QUESTION

Operating Cash Flow (OCF) for the Project

Operating Cash Flow (OCF) = [(Annual Sales - Costs) x (1 – Tax Rate)] + [Depreciation x Tax Rate]

= [($650,000 - $300,000) x (1 – 0.25)] + [($1,250,000 / 5 Years) x 0.25]

= [$350,000 x 0.75] + [$250,000 x 0.25]

= $262,500 + $62,500

= $325,000

The Net Present Value (NPV) of the Project

Year	Annual cash flows ($)	Present Value Factor (PVF) at 7.00%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	3,25,000	0.9345794	3,03,738
2	3,25,000	0.8734387	2,83,868
3	3,25,000	0.8162979	2,65,297
4	3,25,000	0.7628952	2,47,941
5	3,25,000	0.7129862	2,31,721
TOTAL		1,332,564

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $1,332,564 - $1,250,000

= $82,564

“Hence, the Net Present Value (NPV) of the Project will be (a). $82,564”

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)n], Where “r” is the Discount/Interest Rate and “n” is the number of years.

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