Down Under Boomerang, Inc., is considering a new three-year expansion project th
ID: 2743266 • Letter: D
Question
Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.49 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,010,000 in annual sales, with costs of $705,000. The tax rate is 34 percent and the required return is 16 percent. The project requires an initial investment in net working capital of $230,000, and the fixed asset will have a market value of $295,000 at the end of the project.
What is the project's Year 0 net cash flow? Year 1? Year 2? Year 3?
What Is the NPV?
Explanation / Answer
Solution :- Cash flow in Year 0 = (-) 2720000 (2490000 + 230000).
Negative sign indicates the outflow of cash in the Year 0 (At beginning of project).
Calculation of operating cash flow
Sales
(-) Costs
2010000
705000
Earnings before depreciation & tax
(-) Depreciation (2490000 / 3)
1305000
830000
Earnings before tax
(-) Tax expense (34 % of 475000)
475000
166250
Net income
(+) Depreciation
313500
830000
Cash flow in Year 1 = $ 1143500.
Cash flow in Year 2 = $ 1143500.
Cash flow in Year 3 = 1143500 + 230000(Salvage value of working capital is considered to be 100 %) + 295000 * (1 - 0.34)
= 1143500 + 230000 + 194700
= $ 1568200.
Net present value = Present value of cash inflows - Present value of cash outflow.
Present value of cash inflows = 1143500 / (1 + 0.16)1 + 1143500 / (1 + 0.16)2 + 1568200 / (1 + 0.16)3
= 1143500 / (1.16)1 + 1143500 / (1.16)2 + 1568200 / (1.16)3
= 1143500 / 1.16 + 1143500 / 1.3456 + 1568200 / 1.560896
= 985775.86 + 849806.78 + 1004679.36
= $ 2840262.
Present value of cash outflow = $ 2720000.
Accordingly, Net present value (NPV) of Project = 2840262 - 2720000.
= $ 120262.
Conclusion :-
Particulars Amount ($)Sales
(-) Costs
2010000
705000
Earnings before depreciation & tax
(-) Depreciation (2490000 / 3)
1305000
830000
Earnings before tax
(-) Tax expense (34 % of 475000)
475000
166250
Net income
(+) Depreciation
313500
830000
Operating cash flow 1143500Related Questions
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