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Green Monstah Landscaping Corp. is considering some new equipment whose data are

ID: 2635044 • Letter: G

Question

Green Monstah Landscaping Corp. is considering some new equipment whose data are shown below. THe equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value at the end of Year 3, when the equipment would be sold. Also, additional net operating working capital would be required, but it would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV?

Explanation / Answer

Solution:

Step 1: Calculation of initial investment:

Net investment in fixed assets = $70,000

New working capital required = $10,000

Total initial investment = $80,000

Step 2: Calculation of After-tax cash flows

Year 1 Year 2 Year 3

Sales

$ 67,000.00

$ 67,000.00

$ 67,000.00

Less: Op.costs excl. depr.

$ 30,000.00

$ 30,000.00

$ 30,000.00

Less: Depreciation

$ 23,333.33

$ 23,333.33

$ 23,333.33

EBIT

$ 13,666.67

$ 13,666.67

$ 13,666.67

Less: Interest expense

$ -

$ -

$ -

Earnings before taxes

$ 13,666.67

$ 13,666.67

$ 13,666.67

Less: Taxes at 35%

$ 4,783.33

$ 4,783.33

$ 4,783.33

Earnings after taxes

$ 8,883.33

$ 8,883.33

$ 8,883.33

Add: Depreciation expense

$ 23,333.33

$ 23,333.33

$ 23,333.33

Cash flows after taxes

$ 32,216.67

$ 32,216.67

$ 32,216.67

Step 3: Calculation of Terminal cash flows:

Book value of the equipment at the end of year 3 = 0

Therefore, the entire salvage value is profitable and taxable.

Salvage value = $5,000

Tax on profit on salvage value = $5,000 x 35% $1,750

After tax salvage value = $5,000- $1,750 = $3,250

Terminal values:

Working capital released = $10,000

After-tax salvage value = $3,250

Total terminal cash flows = $13,250

Step 4: Calculation of NPV:

Year

PV factor

Cash

PV of cash

at 10%

flows

flows

0

1.0000

$ (80,000.00)

$ (80,000.00)

1

0.9091

$ 32,216.67

$ 29,287.88

2

0.8264

$ 32,216.67

$ 26,625.34

3

0.7513

$ 32,216.67

$ 24,204.86

3

0.7513

$ 13,250.00

$ 9,954.92

NPV =

$ 10,073.00

Therefore, the NPV is $10,073.

This project can be accepted because NPV>0.

Sales

$ 67,000.00

$ 67,000.00

$ 67,000.00

Less: Op.costs excl. depr.

$ 30,000.00

$ 30,000.00

$ 30,000.00

Less: Depreciation

$ 23,333.33

$ 23,333.33

$ 23,333.33

EBIT

$ 13,666.67

$ 13,666.67

$ 13,666.67

Less: Interest expense

$ -

$ -

$ -

Earnings before taxes

$ 13,666.67

$ 13,666.67

$ 13,666.67

Less: Taxes at 35%

$ 4,783.33

$ 4,783.33

$ 4,783.33

Earnings after taxes

$ 8,883.33

$ 8,883.33

$ 8,883.33