P10-12 NPV and Modified ACRS [LO1] Summer Tyme, Inc., is considering a new 3-yea

Question

P10-12 NPV and Modified ACRS [LO1]

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $6.5 million. The fixed asset falls into the 3-year MACRS class (MACRS Table) and will have a market value of $504,000 after 3 years. The project requires an initial investment in net working capital of $720,000. The project is estimated to generate $5,760,000 in annual sales, with costs of $2,304,000. The tax rate is 35 percent and the required return on the project is 13 percent. (Do not round your intermediate calculations.)

    

   

  

  

  

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $6.5 million. The fixed asset falls into the 3-year MACRS class (MACRS Table) and will have a market value of $504,000 after 3 years. The project requires an initial investment in net working capital of $720,000. The project is estimated to generate $5,760,000 in annual sales, with costs of $2,304,000. The tax rate is 35 percent and the required return on the project is 13 percent. (Do not round your intermediate calculations.)

Explanation / Answer

Part A)

The cash flow in year 0 would comprise of initial investment and working capital required at beginning of the project. The formula is given below:

Cash Flow (Year 0) = -Initial Investment - Working Capital

_________

Using the values provided in the question, we get,

Cash Flow (Year 0) = -6,500,000 - 720,000 = -$7,220,000

_________

Part B, C and D have been answered with the use of following table:

Notes:

1) Depreciation is calculated on the cost of fixed asset only.

2) The gain of $22,350 is the difference between the market value and the salvage value (504,000 - 481,650). $481,650 is the book value arrived at after deducting the value of depreciation from Year 1 to Year 3 from the cost of fixed asset.

_________

Part E)

The net present value can be calculated with the use of following formula:

NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Required Return)^1 + Cash Flow Year 2/(1+Required Return)^2 + Cash Flow Year 3/(1+Required Return)^3

_________

Using the values calculated in Part A to Part D, we would get,

NPV = -7,220,000 + 3,004,658/(1+13%)^1 + 3,257,638/(1+13%)^2 + 3,799,505/(1+13%)^3 = $623,444.51 or $623.445 9which is nearest to 623,444.51.

Year 1 Year 2 Year 3 Sales 5,760,000 5,760,000 5,760,000 Less Costs 2,304,000 2,304,000 2,304,000 Less Depreciation 2,166,450 (33.33%) 2,889,250 (44.45%) 962,650 (14.81%) Profit Before Taxes 1,289,550 5,66,750 2,493,350 Less Taxes 451,343 198,363 872,673 Profit After Taxes 838,208 368,388 1,620,678 Add Depreciation 2,166,450 2,889,250 962,650 Add Recovery of Working Capital 0 0 720,000 Add Market Value 0 0 504,000 LessTax on Gain 0 0 -7,823 Net Cash Flow $3,004,658 $3,257,638 $3,799,505

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