12-6 Project Cash Flows KADS, Inc., has spent $400,000 on research to develop a

Question

12-6  Project Cash Flows KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is planning to spend $200,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of three years, a $75,000 estimated resale value, and falls under the MACRS 7-year class life. Revenue from the new game is expected to be $600,000 per year, with costs of $250,000 per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $100,000 at the beginning of the project. What will the cash flows for this project be? (LG12-3)

Explanation / Answer

Calculation net present value of cash flows:

Step1:

Revenue from the new game $600,000

Less:Operating cost ($250,000)

   Depreciation ($82,143)

Net operating income $267,857

Less:Tax ($350,000*0.35) ($93,750)

Net operating income after tax $174,107

Add:Depreciation (From step 2) $82,143

Cash inflows per year $256,250

Step2:

Depreciation=($400,000+$200,000+$50,000-$75,000)/7 =$82,143

Step3:

NPV=-Present value of Intial cash out flow+Present value of cash inflow flow +present value of salvage value

=-$650,000-$100,000+$256,250*PVAF for 7Years @15%+$75,00*PV of 7th year @15%+$75,000*PV of 7th year@15%+$100,000*PV of 7th year@1%

=-$750,000+$256,250*4.16+$175,000*0.3759

=-$750,000+$1,066,107+$65,789

NPV=$381,895

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