Question

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $2.8 million. The fixed asset falls into the 3-year MACRS class (MACRS Table) and will have a market value of $214,200 after 3 years. The project requires an initial investment in net working capital of $306,000. The project is estimated to generate $2,448,000 in annual sales, with costs of $979,200. The tax rate is 31 percent and the required return on the project is 14 percent. (Do not round your intermediate calculations.)

Required:

(a) What is the project's year 0 net cash flow?

(b) What is the project's year 1 net cash flow?

(c) What is the project's year 2 net cash flow?

(d) What is the project's year 3 net cash flow?

(e) What is the NPV?

Answer 1

Initial Investment = $2,800,000
Useful Life = 3 years

Depreciation Year 1 = 33.33% * $2,800,000
Depreciation Year 1 = $933,240

Depreciation Year 2 = 44.45% * $2,800,000
Depreciation Year 2 = $1,244,600

Depreciation Year 3 = 14.81% * $2,800,000
Depreciation Year 3 = $414,680

Book Value at the end of Year 3 = $2,800,000 - $933,240 - $1,244,600 - $414,680
Book Value at the end of Year 3 = $207,480

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $214,200 - ($214,200 - $207,480) * 0.31
After-tax Salvage Value = $212,116.80

Initial Investment in NWC = $306,000

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$2,800,000 - $306,000
Net Cash Flows = -$3,106,000

Year 1:

Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($2,448,000 - $979,200) * (1 - 0.31) + 0.31 * $933,240
Operating Cash Flow = $1,302,776.40

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $1,302,776.40

Year 2:

Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($2,448,000 - $979,200) * (1 - 0.31) + 0.31 * $1,244,600
Operating Cash Flow = $1,399,298.00

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $1,399,298.00

Year 3:

Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($2,448,000 - $979,200) * (1 - 0.31) + 0.31 * $414,680
Operating Cash Flow = $1,142,022.80

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $1,142,022.80 + $306,000 + $212,116.80
Net Cash Flows = $1,660,139.60

Required Return = 14%

NPV = -$3,106,000 + $1,302,776.40/1.14 + $1,399,298.00/1.14^2 + $1,660,139.60/1.14^3
NPV = $234,047.63