Question

"A manufacturing company has just received an order with the following financial data. All dollar values are given in constant dollars, and inflation will impact the annual revenue, annual operating cost, and the salvage value. The two-year project requires immediately purchasing equipment for $90,000. The equipment falls into the MACRS 5-year class. The machine will be sold for $12,000 at the end of two years. The project will bring in additional annual revenue of $107,000, but it is expected to incur an additional annual operating cost of $28,000. The firm expects a general inflation rate of 7% per year during the project period. The firm's tax rate is 2196, and its market interest rate is 20%. What is the net present worth of this project?"

Answer 1

Refer Table below for Solution:

Investment at 0th Year is made of $ 90,000 hence negative sign is used.

Revenue for 1st year is given as $107000, for 2nd year it is to be inflated by 7% hence Revenue for 2nd year will be =  107000*1.07= $114490

Operating Cost for 1st year is given as $28000, for 2nd year it is to be inflated by 7% hence Operating Cost for 2nd year will be =  28000*1.07= $29960

Depreciation as per MACRS 5 year Class is 20% for first year and 32% for 2nd year. Hence Depreciation for first year is 20% * 90000 = $18000 and for 2nd year 32% * 90000= $28800

Hence Profit Before Tax (PBT) is calculated by doing Revenue- Operating Cost- Depreciation. Hecne for First year (107000-28000-18000)= $61000, for 2nd year (114490-29960-28800)=$55730

Tax is calculated at 21% of PBT. Hecne for first year 21%*61000=$12810, for 2nd year 21%*55730=$11703.3

Hence Profit (PAT) will be (PBT- Tax), for first year (61000-12810)=$48190, for 2nd year (54150-11703.3)= $44026.7

Salvage value at end of 2 year is given $ 12000

Cashflow for Year 0 (CF0) -90,000

Cashflow for year 1(CF1)= PAT+ Depreciation= 48190+18000= $66190 (Depreciation is added in cashflow as it is a non cash expenditure)

Cashflow for year 2 (CF2)= PAT + Depreciation + Salvage Value= 44026.7 + 28800 + 12000= $84826.7

Discount Rate for calculating present value is given as 20% (R)

PV for year 0 (PV0) = CF0 / (1+R)^0 = -90,000 / (1+20%)^0 =$-90,000

PV for year 1 (PV1) = CF1 / (1+R)^1 = 66190 / (1+20%)^1 = 66190 / 1.2 =$ 55158.33

PV for year 2 (PV2) = CF2 / (1=R)^2 = 84826.7 / (1+20%)^2 = 84826.7 / 1.44 =$58907.43

Hence Net Present Worth fo the Project = PV0 + PV1 + PV2 = -90000 + 55158.33+ 58907.43 = $ 24065.76

	Year
	0	1	2
Investment	-90,000.00
Revenue (R)		1,07,000.00	1,14,490.00
Operating Cost (O)		28,000.00	29,960.00
Depreciation (D)		18,000.00	28,800.00
Profit Before Tax- PBT= (R-O-D)		61,000.00	55,730.00
Tax @ 21% (T)		12,810.00	11,703.30
Profit After Tax - PAT= (PBT- T)		48,190.00	44,026.70
Salvage Value			12,000.00
Depreciation Add Back		18,000.00	28,800.00
Cashflow	-90,000.00	66,190.00	84,826.70
PV @ 20%	-90,000.00	55,158.33	58,907.43
NPV	24,065.76