Question

Thurston Petroleum is considering a new project that complements its existing business. The machine required for the project costs $4.2 million. The marketing department predicts that sales related to the project will be $2.43 million per year for the next four years, after which the market will cease to exist. The machine will be depreciated to zero over its 4-year economic life using the straight-line method. Cost of goods sold and operating expenses related to the project are predicted to be 30 percent of sales. The company also needs to add net working capital of $160,000 immediately. The additional net working capital will be recovered in full at the end of the project’s life. The tax rate is 22 percent and the required return for the project is 11 percent.

  

What is the value of the NPV for this project?

Answer 1

NPV = Present value of cash inflows - Present value of cash outflows
	Year 0	Year 1	Year 2	Year 3	Year 4
Purchase cost of machine	(4,200,000)
Working capital	(160,000)
Sales		2,430,000	2,430,000	2,430,000	2,430,000
Less: COGS and Operating Expenses		729,000	729,000	729,000	729,000
Depreciation		1,050,000	1,050,000	1,050,000	1,050,000
Earnings before tax		651,000	651,000	651,000	651,000
Less: Tax@22%		143,220	143,220	143,220	143,220
Net Income		507,780	507,780	507,780	507,780
Add: Depreciation(non-cash expense)		1,050,000	1,050,000	1,050,000	1,050,000
Working capital Release					160,000
Cash flows	(4,360,000)	6,561,000	6,561,000	6,561,000	6,721,000
Discount factor	1	0.901	0.812	0.731	0.659
Discounted cash flows	(4,360,000)	5,911,461	5,327,532	4,796,091	4,429,139
NPV	16,104,223