The Taylor Mountain Uranium Company currently has annual cash revenues of $1.2 m
ID: 2655655 • Letter: T
Question
The Taylor Mountain Uranium Company currently has annual cash revenues of $1.2 million and annual cash expenses of $700,000. Depreciation amounts to $200,000 per year. These figures are expected to remain constant for the foreseeable future (at least 15 years). The firm’s marginal tax rate is 40 percent. A new high-speed processing unit costing $1.2million is being considered as a potential investment designed to increase the firm’s output capacity. This new piece of equipment will have an estimated usable life of 10 years and a $0 estimated salvage value. If the processing unit is bought, Taylor’s annual revenues are expected to increase to $1.6 million and annual expenses (exclusive of depreciation) will increase to $900,000. Annual depreciation will increase to $320,000. Assume that no increase in net working capital will be required as a result of this project. Compute the project’s annual net cash flows for the next 10 years; assuming that the new processing unit is purchased. Also compute the net investment (NINV) for this project.
Explanation / Answer
Annual Revenues from the project = $1600000- $1200000 = $400000
Annual expenses from the project = $900000- $700000 = $200000
Annual depreciation from the project = $320000 -$200000 = $120000
Annual tax savings on depreciation = 120000*0.4 = $48000
Annual net savings excluding depreciation tax savings = Annual revenues - Annual expenses = 400000 -200000 = $200000
Annual net savings excluding depreciation tax savings (Net of tax) = 200000*(1-0.40) = $120000
Annual net cash flows from the project for next 10 years= 120000 + tax savings on depreciation = 120000 + 48000 = $168000
Net investment means the amount spent by a company or an economy on capital assets, or gross investment, less depreciation.
Thus, net investment = 1200000 - 120000 = $1080000
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