a. Calculate the NPV for the following capital budgeting proposal: $100,000 init

Question

a. Calculate the NPV for the following capital budgeting proposal: $100,000 initial cost, to be depreciated straight-line over five years to an expected salvage value of $5,000, 35% tax rate, $45,000 additional annual revenues, $15,000 additional annual expense, $8,000 additional investment in working capital, 11% cost of capital.

b. Recalculate the NPV for the proposal, now assuming that the $45,000 in annual revenues will grow at a 6% annual rate and that the $15,000 in annual expenses will grow at a 5% annual rate. Does this change your decision on the project?

  

Calculate the NPV for the following capital budgeting proposal: $100,000 initial cost, to be depreciated straight-line over five years to an expected salvage value of $5,000, 35% tax rate, $45,000 additional annual revenues, $15,000 additional annual expense, $8,000 additional investment in working capital, 11% cost of capital. Recalculate the NPV for the proposal, now assuming that the $45,000 in annual revenues will grow at a 6% annual rate and that the $15,000 in annual expenses will grow at a 5% annual rate. Does this change your decision on the project?

Explanation / Answer

Hi,

Pleae find the answer as follows:

Part 2

Initial Investment = -100000 - 8000 = -108000

Annual Cash Inflow = (Additional Revenues - Additional Expenses - Depreciation)*(1- tax rate) + Annual Depreciation = (45000 - 15000 - 95000/5)*(1-.35) + 95000/5 = 26150

NPV = --108000 + 26150/(1+.11)^1 + 26150/(1+.11)^2 + 26150/(1+.11)^3 + 26150/(1+.11)^4 + 26150/(1+.11)^5 + 5000/(1+.11)^5 + 8000/(1+.11)^5 = -3637.43

Answer is -3637.43

Part B:

Revised Annual Cash Inflow Statement:

NPV = -108000 + 27417.50/(1+.11)^1 + 28765.93/(1+.11)^2 + 30200.37/(1+.11)^3 + 31726.27/(1+.11)^4 + 33349.35/(1+.11)^5 + 8000/(1+.11)^5 + 5000/(1+.11)^5 = 10534.93

Since, the NPV is positive after the revision, the project should be accepted now.

Thanks.

Year 1 Year 2 Year 3 Year 4 Year 5 Annual Revenues 47700 50562 53595.72 56811.46 60220.15 Less Annual Expenses 15750 16537.5 17364.38 18232.59 19144.22 Less Depreciation 19000 19000 19000 19000 19000 Earnings Before Tax 12950.00 15024.50 17231.35 19578.87 22075.93 Less Taxes 4532.50 5258.58 6030.97 6852.60 7726.57 Earnings After Tax 8417.50 9765.93 11200.37 12726.27 14349.35 Add Depreciation 19000 19000 19000 19000 19000 Annual Cash Inflow 27417.50 28765.93 30200.37 31726.27 33349.35

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