Cochrane, Inc., is considering a new three-year expansion project that requires

Question

Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.43 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 $2,260,000 in annual sales, with costs of $1,250,000. Assume the tax rate is 40 percent and the required return on the project is 8 percent.

Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.43 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 $2,260,000 in annual sales, with costs of $1,250,000. Assume the tax rate is 40 percent and the required return on the project is 8 percent.

Explanation / Answer

CF0 = the asset + the increase in Net Working Capital [NWC, recovered in the last period] = (2.591m)< a negative number to reflect OUTflow
CFs 1 & 2
first calc depreciation: 2.43m/3years = 810,000
after tax cash flow: (revenue 2,260,000 - expenses 1,250,000 - depreciation 810,000) * (1 - tax: 0.60) = 200,000 + add back depreciation [non-cash] 810,000 = $1,010,000

CF3 = CF2 + after tax proceeds from sale [you calc "as if" the asset is sold for market value] + recapture NWC...
after tax proceeds from sale: (sale price - book)(1 - tax) = 186,000(0.60) = 111,600
so CF3 = 1,010,000 + 111,600 + 161,000 = 1,282,600

NPV = (2,591,000) + 1,010,000/1.08 + 1,010,000/1.08^2 + 1,282,600/1.08^3 = $228,266.63

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