Wheel Industries is considering a three-year expansion project. The project requ

Question

Wheel Industries is considering a three-year expansion project.
The project requires an initial investment of $1.5 million. The project will use straight-line depreciation method. The project has no salvage value. It is estimated that the project will generate additional revenues of $1.2 million per year and has annual costs of $600,000.

The tax rate is 35 percent. Calculate the cash flows for the project. If the discount rate were 6 percent, calculate the NPV of the project, then offer your thoughts as to whether this is an economically acceptable project to undertake.

Explanation / Answer

NPV = $63,655.34 Yes it is. $1,500,000 value, depreciated linearly over 3 years. $1,200,000 million revenue generated per year And an additional $600,000 in expenses per year So a net profit of $600,000 annually * 35% tax rate = $390,000 income Cash flows yearly would be: -$1,500,000 $600,000 $600,000 $600,000 After applying the tax shield: -$975000 $390000 $390000 $390000 NPV = $63,655.34 So yes, this is an economically acceptable project, if there are no better alternative projects.

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