10. A 3-year project will cost $120,000 to construct. This will be depre ciated

Question

10. A 3-year project will cost $120,000 to construct. This will be depre ciated traight line to zero over the 3-year life. The project is expected to gene rate sales of $250,000 per year. It s annual variables costs of $100,000 and annual fixed costs of $50,000 per year. The appropriate tax rate is 25 percent and the required rate of return on the project is 15 percent. Assume a salvage company will pay $60,000 (before taxes) for the assets at the end of year e project also has an initial net working capital requirement of $30,000, which is fully recoverable when the project ends. Note that the project only depreciates the $120,000 initial cost. The salvage value is excluded from depreciation. What is the project's net present value 3. Th (NPV)?

Explanation / Answer

We will first have to compute the depreciation for 3 years which is based on straight line method 120000-60000/3 100000 Depreciation per year 100000 Free cash flows per year Sales - Annual variable cost - annual fixed costs 250000-100000-50000 100000 Tax @ 25% 25000 Free cash flows 75000 Cash outflow in $ Project Cost 120000 Initial working capital 30000 Total cash out flow 150000 Cash Inflows Present value of free cash flows - 75000*(1-(1/1.15^3)/0.15) 171241.9 Present value of Tax savings on depreciation -100000*(1-(1/1.15^3)/0.15) 228322.5 Present value of salvage after tax 60000*75%*(1/1.15^3) 29588.22 Present value of recovery of working capital 30000*(1/1.15^3) 19725.49 Total Cash Inflow 448878.107 Net Present Value = Cash Inflow - Cash Outflow 298878.107 The Net present value is $298878.11

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