A company is considering a 3-year project that requires an initial installed equ

Question

A company is considering a 3-year project that requires an initial installed equipment cost of $14,000. The project engineer has estimated that the operating cash flows will be $5,000 in year 1, $6,000 in year 2, and $8,000 in year 3. The new machine will also require a parts inventory of $1,000 at the beginning of the project (assume this inventory can be sold for cost at the end of the project). It is also estimated that the equipment can be sold as salvage for an after tax salvage cash flow of $5,000 at the end of the project. If the tax rate is 40% and the required rate of return is 15%, what is the net present value (NPV) of this project? (Answer to the nearest dollar.)

Selected Answer: Incorrect -1,117

Correct Answer: Correct 3,090 ± 1 <<<< HOW WAS THIS ANSWER OBTAINED?

Explanation / Answer

Initial investment = cost of equipment + increase in working capital

Initial investment = 14,000 + 1,000 = 15,000

Year 3 non operating cash flow = after tax salvage value + recovered working capital

Year 3 non operating cash flow = 5,000 + 1,000 = 6000

NPV = Present value of cash inflows - present value of cash outflows

NPV = -15000 + 5000 / ( 1 + 0.15)1 + 6000 / ( 1 + 0.15)2 + 8000 / ( 1 + 0.15)3 + 6000 / ( 1 + 0.15)3

NPV = $3,090

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