As a financial manager for a company, you are considering a proposed project whi

Question

As a financial manager for a company, you are considering a proposed project which requires an investment of $750,000 in fixed assets. The project has a five-year useful life but is classified as three-year MACRS property for tax purposes. The required initial net working capital investment is $120,000, which can be fully recovered at the end of the project’s life. The marginal tax rate of your company is 34%, and the project discount rate is 11%. The annual sales and operating cost excluding depreciation are estimated to be $550,000 and $280,000, respectively. The project can be scrapped for a market value of $60,000 (before tax) at the end of its life. Should the project be accepted?

Explanation / Answer

All Amounts in $ Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 MACRS Depreciation rate                   33.33                  44.45              14.81             7.41 Initial Invenstment       (750,000) Initial net WC Investment       (120,000)          120,000 Salvage value            60,000 Sales revenue              550,000              550,000         550,000      550,000          550,000 Opearting Cost            (280,000)           (280,000)       (280,000) (280,000)       (280,000) Depreciation            (249,975)           (333,375)       (111,075)      (55,575)                     -   Total Pretax Income                 20,025              (63,375)         158,925      214,425          330,000 Tax @34%                   6,809              (21,548)            54,035        72,905          112,200 Post Tax Income                 13,217              (41,828)         104,891      141,521          217,800 Add back Depreciation              249,975              333,375         111,075        55,575                     -   Total Cash Flow              263,192              291,548         215,966      197,096          217,800 Discount factor @11%                      1                   0.901                  0.812              0.731          0.659              0.593 PV of Cash Inflow              237,109              236,626         157,912      129,833          129,254 Total PV of cash Inflow         890,735 NPV            20,735 As the NPV is positive , the project may be accepted

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