KADS, Inc., has spent $400,000 on research to develop a new computer game. The f
ID: 2719085 • Letter: K
Question
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
Year 0 cash Flow = - Machine cost - Shipping and installation costs - Initial Investment in working capital
Year 0 cash Flow = -200000-50000 - 100000
Year 0 cash Flow = -350000
Total machine Cost = Machine cost + Shipping and installation costs
Total machine Cost = 200000+50000
Total machine Cost = 250000
Year 1 Cash Flow = (Revenue - Cost)*(1-tax rate) + Depreciation * Tax rate
Year 1 Cash Flow = (600000-250000)*(1-35%) + 250000*14.29%*35%
Year 1 Cash Flow = 240003.75
Year 2 Cash Flow = (Revenue - Cost)*(1-tax rate) + Depreciation * Tax rate
Year 2 Cash Flow = (600000-250000)*(1-35%) + 250000*24.49%*35%
Year 2 Cash Flow = 248,928.75
Year 3 Cash Flow = (Revenue - Cost)*(1-tax rate) + Depreciation * Tax rate + Working Capital recovered + Post tax salvage value
Year 3 Cash Flow = (600000-250000)*(1-35%) + 250000*17.49%*35% + 100000 + (75000 - 35%*(75000 - 250000*(1-14.29%-24.49%- 17.49%)))
Year 3 Cash Flow = $ 429,817.50
Answer
Year 0 cash Flow = -350000
Year 1 Cash Flow = 240003.75
Year 2 Cash Flow = 248,928.75
Year 3 Cash Flow = $ 429,817.50
Note :
NPV = -350000+ 240003.75/1.15 + 248928.75/1.15^2 + 429,817.50/1.15^3
NPV = $ 329,536.79
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