Down Under Boomerang, Inc., is considering a new three-year expansion project th

Question

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.76 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,100,000 in annual sales, with costs of $795,000. The tax rate is 34 percent and the required return is 12 percent. The project requires an initial investment in net working capital of $320,000, and the fixed asset will have a market value of $220,000 at the end of the project.

What is the project's Year 0 net cash flow? Year 1? Year 2? Year 3?

Years                             Cash Flow

Year 0                             $

Year 1                              $

Year 2                              $

Year 3                              $

What is the NPV?

Explanation / Answer

Year 0 cash flow = Initial Investmetn -$2,760,000- working capital$320,000= -$3080,000

The cash outflow at the begining of year 0 will increase as result of net working capital but it will recover it at the end of year 3 so it will be cash inflow in that year. The sale of equipment is also cash inflow but we will consider its after tax effect. So the cashflows for each year of project will be as follows:

Operating Cash flow = (Sales- cost) (1-t) + Depreciation * tax rate

=($2,100,000 - $795,000) (1-0.34) + ($2,760,000/3 *0.34)

= $1174,100

In years 1 and 2 , the only cash flow is operating cash flow. In year 3 the total cashflow will include recovery of working capital and after tax slavage value, so:

Year 3 = $1174,100 +$320,000+$220,000(1-0.34) =$1639,300

NPV of the project = -$3080,000 + $1174,100 (PVIFA,12%,2) + $1639,300/ (1.12)3

= $71,110

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