Keiper, Inc., is considering a new three-year expansion project that requires an
ID: 2547832 • Letter: K
Question
Keiper, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.7 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,080,000 in annual sales, with costs of $775,000. The project requires an initial investment in net working capital of $300,000, and the fixed asset will have a market value of $210,000 at the end of the project. If the tax rate is 35 percent, what is the projects year 0 net cash flow? Year 1? Year 2? Year 3?
Years Cash Flows Year 0 $ Year 1 $ Year 2 $ Year 3 $Explanation / Answer
Initial Investment = $2,700,000
Life of Project = 3 years
Annual Depreciation = $2,700,000 / 3
Annual Depreciation = $900,000
Initial Investment in Net Working Capital = $300,000
Annual OCF = (Annual Sales - Annual Costs)*(1 - tax) + tax*Annual Depreciation
Annual OCF = ($2,080,000 - $775,000)*(1-0.35) + 0.35*$900,000
Annual OCF = $1,163,250
Salvage Value = $210,000
After-tax Salvage Value = $210,000*(1-0.35)
After-tax Salvage Value = $136,500
Year 0:
Net Cash Flow = -$2,700,000 - $300,000
Net Cash Flow = -$3,000,000
Year 1:
Net Cash Flow = $1,163,250
Year 2:
Net Cash Flow = $1,163,250
Year 3:
Net Cash Flow = $1,163,250 + $136,500 + $300,000
Net Cash Flow = $1,599,750
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