Question

Down Under Boomerang, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $2.29 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life. The project is estimated to generate $1,715,000 in annual sales, with costs of $625,000. The project requires an initial investment in net working capital of $260,000, and the fixed asset will have a market value of $195,000 at the end of the project.

a.	If the tax rate is 21 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, e.g., 1,234,567. A negative answer should be indicated by a minus sign.)
b.	If the required return is 9 percent, what is the project's NPV?

Answer 1

a) Calculation of Project Cash flows year wise

Particulars	Year 0	Year 1	Year 2	Year 3
Cash Outflows:
Fixed Asset Investment	$(2,290,000.00)
Working Capital Invested	$(260,000.00)
Total Cash Outflow	$(2,550,000.00)
Cash Inflows:
Annual Sales		$1,715,000.00	$1,715,000.00	$1,715,000.00
Less: Operating Cost		$(625,000.00)	$(625,000.00)	$(625,000.00)
Less: Depreciation (note 1)		$(763,333.33)	$(763,333.33)	$(763,333.33)
Profit before tax		$326,666.67	$326,666.67	$326,666.67
Less : Tax @ 21%		$(68,600.00)	$(68,600.00)	$(68,600.00)
Profit after tax		$258,066.67	$258,066.67	$258,066.67
Add: Depreciation		$763,333.33	$763,333.33	$763,333.33
Add: Sale Value of asset net of tax (note 2)				$154,050.00
Add: Recovery of working capital (note 3)				$260,000.00
Total Cash Inflows		$1,021,400.00	$1,021,400.00	$1,435,450.00
Total cash flows	$(2,550,000.00)	$1,021,400.00	$1,021,400.00	$1,435,450.00

Note

1. Calculation of Depreciation

Original Price	$2,290,000.00
Less: salvage value	$-
Depreciable value ,,A	$2,290,000.00
Life ...B	3
Depreciation ...A/B	$763,333.33

2. Calculation of Sale Value of asset net of tax

Sale Value of Asset	$195,000.00
Less: WDV at the end of Yr 3	$-
Profit on sale	$195,000.00
Less: Tax @ 21%	$(40,950.00)
Salvage Value of asset net of tax	$154,050.00

3. It has been assumed the working capital invested initially will be released after completion of the project.

b) Calculation of NPV, If the required return is 9 percent

NPV = Present Value of Cash Inflows - Present Value of Cash Outflows

Particulars	Year 0	Year 1	Year 2	Year 3
Total cash flows ...A	$(2,550,000.00)	$1,021,400.00	$1,021,400.00	$1,435,450.00
PVF @ 9% ...B	1	0.917431193	0.841679993	0.77218348
Present Value of Cash Flows ...A*B	$(2,550,000.00)	$937,064.22	$859,691.95	$1,108,430.78

NPV = $(2,550,000.00)+ $937,064.22+$859,691.95+ $1,108,430.78
NPV = $355,186.94

Note :
PVF(r,t) = (1/(1+r))^n