Apnea Video Rental Store is considering the purchase of an almost new minivan to

Question

Apnea Video Rental Store is considering the purchase of an almost new minivan to deliver and pick up video tapes from customers. The minivan will cost $125,000 and is expected to last 10 years. In addition, purchasing this minivan would require an immediate investment of $60,000 in working capital which would be released for investment elsewhere at the end of the 10 years. The minivan is expected to have a $10,000 salvage value at the end of 10 years. This delivery service is expected to generate net cash inflows of $50,000 per year in each of the 10 years. However, the minivan is expected to need an overhaul costing $20,000 at the end of the sixth year. Apnea has a cost of capital of 10% and an income tax rate of 40%.

Calculate the net present value (NPV) of this investment opportunity.

Thank you!

Explanation / Answer

Depreciation: (125,000 - salvage 10k) / 10 = 11,500
Tax shield due to depreciation: 11,500*0.40 = 4,600

(note: this - below - assumes your other "net cash inflows" does not account for the tax shield due to depreciation)

Lay out your cash flows:
CF0: (125k + 60k NWC "net working capital") = (185k)
CFs1 thru 5: 50k + tax shield 4.6k = 54.6k
CF6 = 54.6k - 20k = 34.6k
CFs 7 thru 9 = 54.6k
CF10: 54.6k +recapture NWC 60k + salvage 10k = 124.6k

then discount the cash flows at 10%...
NPV = (185k) + 54.6/1.10 + 54.6/1.10^2 +...(insert intervening CFs 3 thru 5 here) + 34.6k/1.10^6 + 54.6k/1.10^7 + ..(intervening CFs 7 thru 9) ..+ 124.6k/1.10^10

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