Question

Buena Vista Industries is considering investing in a new project that will last for three years. The project requires capital expenditures of $75,000 that will be depreciated over three years. In addition, working capital will need to increase by $5,000 in the first year and maintain that level until the end of the project's life, at which point working capital will drop by $5,000. Buena Vista plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental earnings projections: Year Sales (Revenues) Cost of Goods Sold (50% of sales) Depreciation = EBIT Taxes (35%) Incremental Earnings 1 150,000 (75,000) (25,000) 50,000 (17,500) 32,500 2 150,000 (75,000)| (25,000) 50,000 (17,500) 32,500 150,000 (75,000) (25,000) 50,000 (17,500) 32,500 5,000 0 Working Capital 5,000 Based on this analysis, the NPV of Buena Vista's new project is closest closest to which of the following? a $97,500 b. 564,010 $63,105 d. $3,060 $62,200

Answer 1

Net present value is calculated as present value of cash inflow less present value of cash outflow
Calculation of net present value is shown below
Year	0	1	2	3
Incremental earnings		$32,500	$32,500	$32,500
Add: Depreciation		$25,000	$25,000	$25,000
Operating cash flow		$57,500	$57,500	$57,500
Capital expenditure	-$75,000
Working capital	$0	-$5,000		$5,000
Net cash flow	-$75,000	$52,500	$57,500	$62,500
Discount factor @ 12%	$1.0000	$0.8929	$0.7972	$0.7118
	1/(1.12^0)	1/(1.12^1)	1/(1.12^2)	1/(1.12^3)
Present value	-$75,000	$46,875	$45,839	$44,486
Net present value	$62,200
Thus, net present value of new project is $62,200.