Question

Gateway Communications is considering a project with an initial fixed assets cost of $1.49 million that will be depreciated straight-line to a zero book value over the 9-year life of the project. At the end of the project the equipment will be sold for an estimated $246,000. The project will not change sales but will reduce operating costs by $411,000 per year. The tax rate is 34 percent and the required return is 12.1 percent. The project will require $55,000 in net working capital, which will be recouped when the project ends. What is the project's NPV? Multiple Choice

$318,997

$306,728

$329,631

$271,403

$259,603

Answer 1

Answer is $271,403

Initial Investment = $1,490,000
Useful Life = 9 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $1,490,000 / 9
Annual Depreciation = $165,555.56

Initial Investment in NWC = $55,000

Salvage Value = $246,000

After-tax Salvage Value = $246,000 * (1 - 0.34)
After-tax Salvage Value = $162,360

Annual Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = $411,000 * (1 - 0.34) + 0.34 * $165,555.56
Annual Operating Cash Flow = $327,548.89

Required return = 12.10%

NPV = -$1,490,000 - $55,000 + $327,548.89 * PVIFA(12.10%, 9) + $55,000 * PVIF(12.10%, 9) + $162,360 * PVIF(12.10%, 9)
NPV = -$1,545,000 + $327,548.89 * 5.30806 + $217,360 * 0.35773
NPV = $271,403