Question

The Best Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated here. The corporate tax rate is 38 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project Year 1 Year 0 Year 2 Year 3 Year 4 $ 25,000 Investment Sales revenue 13,000 S 13,500 14,000 11,000 2,900 6,250 410 Operating costs Depreciation Net working capital spending 2,800 6,250 360 3,000 6,250 310 2,200 6,250 310 a. Compute the incremental net income of the investment for each year. (Do not round intermediate calculations.) Year 2 Year 3 Year 4 Year 1 $ $ $ $ Net income b. Compute the incremental cash flows of the investment for each year. (Do not round intermediate calculations. A negative answer should be indicated by a minus sign.) Year 1 Year 2 Year 3 Year 4 Year 0 $ $ S $ $ Cash flow c. Suppose the appropriate discount rate is 10 percent. What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV

Answer 1

a.
Calculation of incremental net income for each year
	Year 1	Year 2	Year 3	Year 4
Sales revenue	$13,000	$13,500	$14,000	$11,000
Less: Operating costs	$2,800	$2,900	$3,000	$2,200
Less: Depreciation	$6,250	$6,250	$6,250	$6,250
Income before taxes	$3,950	$4,350	$4,750	$2,550
Less: Taxes @ 38%	$1,501	$1,653	$1,805	$969
Net income	$2,449	$2,697	$2,945	$1,581
b.
Calculation of incremental cash flows of investment each year is shown below
	Year 0	Year 1	Year 2	Year 3	Year 4
Net income		$2,449	$2,697	$2,945	$1,581
Add: Depreciation		$6,250	$6,250	$6,250	$6,250
Operating cash flow		$8,699	$8,947	$9,195	$7,831
Investment	-$25,000
Addition to NWC	-$310	-$360	-$410	-$310	$1,390
Cash flow	-$25,310	$8,339	$8,537	$8,885	$9,221
c.
Calculation of NPV of project
Cash flow (a)	-$25,310	$8,339	$8,537	$8,885	$9,221
Discount factor @ 10% (b)	1	0.9090909	0.8264463	0.7513148	0.683013
	1/(1.1^0)	1/(1.1^1)	1/(1.1^2)	1/(1.1^3)	1/(1.1^4)
Present value	-$25,310.00	$7,580.91	$7,055.37	$6,675.43	$6,298.07
Net present value	$2,299.78