In analyzing a new potential business MacDonald Publishing’s financial staff is
ID: 2733830 • Letter: I
Question
In analyzing a new potential business MacDonald Publishing’s financial staff is estimating an initial capital expenditure of $6.1 million. This equipment will be depreciated according to the MACRS 3 year class life and will have a market value of $1 million after four years. If MacDonald goes ahead with the new business, inventories and accounts payable will increase by $300,000 each. The new business is expected to have an economic life of four years and is expected to generate annual sales of 5 million and incur operating costs (excluding depreciation) of 3 million annually. If the company's tax rate is 40 percent and the required return is 10 percent, calculate the expected NPV of the new business.
Explanation / Answer
Assuming the invetsement in net working capital returned after 4 years. Details Year 0 Year 1 Year 2 Year 3 Year 4 MACRS Rate 33.33% 44.45% 14.81% 7.41% NPV details Investment in Capital Expenditure (6,100,000) Net Working Capital Investment (300,000) 300,000 Annual Sales 5,000,000 5,000,000 5,000,000 5,000,000 Less Operating Costs (300,000) (300,000) (300,000) (300,000) Depreciation expense (2,033,130) (2,711,450) (903,410) (452,010) Salvage 1,000,000 Taxable Income 2,666,870 1,988,550 3,796,590 5,247,990 Tax @40% (1,066,748) (795,420) (1,518,636) (2,099,196) Post Tax Income 1,600,122 1,193,130 2,277,954 3,148,794 Add Back depreciation 2,033,130 2,711,450 903,410 452,010 Post Tax Cash flow = (6,400,000) 3,633,252 3,904,580 3,181,364 3,600,804 PV factor @10% 1 0.9091 0.8264 0.7513 0.6830 PV of Net Cash flows (6,400,000) 3,302,956 3,226,926 2,390,206 2,459,398 NPV = $ 4,979,489.6 So expected NPV =$4,979,489.60
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