Summer Tyme, Inc., is considering a new three-year expansion project that requir

Question

Summer Tyme, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $3.9 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will have a market value of $210,000. The project requires an initial investment in net working capital of $300,000. The project is estimated to generate $2,650,000 in annual sales, with costs of $840,000. The tax rate is 35 percent and the required return on the project is 12 percent. The net cash flow in Year 0 is $; _____ the net cash flow in Year 1 is $; _______the net cash flow in Year 2 is $; _______and the net cash flow in Year 3 is $._____ The NPV for this project is______

Explanation / Answer

Net cash flow in Year 0: fixed asset investment + net working capital investment - 3,900,000 - 300,000 = - 4,200,000 Years 1 and 2: (sales - cost of sales)*(1-T) + depreciation tax gains (annual depreciation*(1-T)) (2,650,000 - 840,000)*(1-0.35) + (3,900,000/3)*(1-0.35) = 1,810,000*0.65 + 1,300,000*0.65 = $2,012,500 Year 3: (sales - cost of sales)*(1-T) + depreciation tax gains (annual depreciation*(1-T)) + after tax scrap value of investment + reversal of net working capital (2,650,000 - 840,000)*(1-0.35) + (3,900,000/3)*(1-0.35) + (210,000 - 0)*(1-0.35) + 300,000 = 1,810,000*0.65 + 1,300,000*0.65 + 210,000*0.65 + 300,000 = $2,458,000 NPV = -4,200,000 + 2,012,500/(1.12) + 2,012,500/(1.12)^2 + 2,458,000/(1.12)^3 = $950,783.53

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