Your company is considering a new project. The required equipment has a 3-year t

Question

Your company is considering a new project. The required equipment has a 3-year tax life, after which it will have zero salvage value. The equipment will be depreciated by the straight-line method over 3 years. The cost of this equipment is $60,000. The project will increase the firm%u2019s revenue by $10,000 and decrease the operating costs by $7,500 per year over the project's 3-year life. The firm falls in 35% tax bracket. The company is financed exclusively by equity, the beta of this company 1.4, the risk free rate is 3% and the market risk premium is 8%.

What is the project's NPV?

Explanation / Answer

ke =cost of capital = 3% + 8% *1.4 = 14.2 %

yearly cash inflow = (10000 + 7500 - 60000/ 3 )* ( 1 - tax rate / 100 ) = -ve

as inflow becomes negative ... so no tax will be calculated ...

so yearly cash flow = 10000 + 7500 = 17500

present value of inflow = 17500/1.142 + 17500/1.142^2 + 17500/1.142^3 = 40425

NPV = -60000 + 40425 = - 19575

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