In analyzing a new potential business MacDonald Publishing’s financial staff is
ID: 2733862 • 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
Answer: NPV = $ 144303.4
Working notes for the above answer is as under
We have been providede with the information that,
capital expenditure of
6,100,000
This equipment will be depreciated by
MACRS 3
Salvage at 4 th year
1,000,000
accounts payablenventory will increase
300,000
Increase in Sales
5,000,000
Increase in operating Expense
3,000,000
Increase in profit
2,000,000
Tax Rate
40%
Now with the help of this figure we will calculate NPV of the project as follow
Calculation of depriciation is as follow as per MACRs 3 year
year
Initial Amount
Dep. Rate
Depriciation
Closing
Balance
DTS=Dep*.40
1
6,100,000
33.33%
2033130
4,066,870
813252
2
6,100,000
44.45%
2711450
1,355,420
1084580
3
6,100,000
14.81%
903410
452,010
361364
4
6,100,000
7.41%
452010
0
180804
Calculation Of NPv
year
Cash Flow
Salvage
Total cash
Inflow
Less : Tax
After Tax
Cash Inlow
Add: DTs
Net Cash
Inflow
Pv Factor
@10%
Prasent Vaue
0
-6,100,000
-6,100,000
1
-6100000
1
2,000,000
2,000,000
800000
1,200,000
813252
2,013,252
0.909091
1830229
2
2,000,000
2,000,000
800000
1,200,000
1084580
2,284,580
0.826446
1888083
3
2,000,000
2,000,000
800000
1,200,000
361364
1,561,364
0.751315
1173076
4
2,000,000
1000000
3,000,000
1200000
1,800,000
180804
1,980,804
0.683013
1352916
144303.4
capital expenditure of
6,100,000
This equipment will be depreciated by
MACRS 3
Salvage at 4 th year
1,000,000
accounts payablenventory will increase
300,000
Increase in Sales
5,000,000
Increase in operating Expense
3,000,000
Increase in profit
2,000,000
Tax Rate
40%
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