Keiper, Inc., is considering a new three-year expansion project that requires an
ID: 2642730 • Letter: K
Question
Keiper, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.67 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 $2,070,000 in annual sales, with costs of $765,000. The project requires an initial investment in net working capital of $290,000, and the fixed asset will have a market value of $265,000 at the end of the project. If the tax rate is 34 percent, what is the project
Keiper, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.67 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 $2,070,000 in annual sales, with costs of $765,000. The project requires an initial investment in net working capital of $290,000, and the fixed asset will have a market value of $265,000 at the end of the project. If the tax rate is 34 percent, what is the project
Explanation / Answer
Part a)
Yearly Cash Flows:
The formula for calculating Yearly Operating Cash Flows Is As Follows:
Operating Cash Flow = (Sales - Costs - Depreciation)*(1-Tax Rate) + Depreciation
Depreciation = Cost/Estimated Life
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Solution:
Year 0 cash flow would be equal to the sum of initial investment and net working capital required at the start of the project = -2,670,000 - 290,000 = -2,960,000
Year 1 and Year 2 cash flow would be calculated with the use of above mentioned formula:
Year 1 Cash Flow = (2,070,000 - 765,000 - 2,670,000/3)*(1-34%) + 2,670,000/3 = $1,163,900
Year 2 Cash Flow = (2,070,000 - 765,000 - 2,670,000/3)*(1-34%) + 2,670,000/3 = $1,163,900
Year 3 Cash Flow would include recovery of working capital and market value after tax as the cash flow = (2,070,000 - 765,000 - 2,670,000/3)*(1-34%) + 2,670,000/3 + 290,000 + 265,000*(1-34%) = $1,628,800
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Cash Flow Table:
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Part b:
NPV is the difference between the present value of future cash inflows an cash flows including initial investment. It is one of the most important capital budgeting techniques used for making decisions on accepting or rejecting the project. If NPV is positive, the project is accepted, otherwise the project is rejected. Present value is calculated by discounting the future cash flows with the use of an appropriate discount rate.
The formula is:
NPV = -PV (Costs) + PV(Benefits)
Present Value (Costs/Benefits) = Year 1 Cash Flow/(1+Discount Rate)^1 + Year 1 Cash Flow/(1+Discount Rate)^3 + Year 1 Cash Flow/(1+Discount Rate)^3 and so on.
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Here discount rate is 13% and Yearly Cash Flows/Benefits have been calculated in Part a)
PV (Yearly Cash Inflows) = 1,163,900/(1+13%)^1 + 1,1639,00/(1+13%)^2 + 1,628,800/(1+13%)^3 = $3,070,344.53
NPV = -2,960,000 + 3070,344.53 = $110,344.53
Years Cash Flow 0 -$2,960,000 1 1,163,900 2 1,163,900 3 1,628,800Related Questions
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