A project requires an initial investment in equipment of $90,000 and then requir

Question

A project requires an initial investment in equipment of $90,000 and then requires an investment in working capital of $10,000 at the beginning (t = 0). The project is expected to produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be 60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the cost of capital is 12%. Calculate the NPV of the project:

A. 14,418

B. 8443

C. -2735

D. None of the above

Explanation / Answer

The correct answer: A. 14,418

Salvage value after tax = $ 10,000 x 0.70 = $ 7,000

NPV at 12 % discount rate = Net annual cash flows x PVIFA 12%, n=3 + ( Salvage value after tax + Working Capital Released ) x PVIF 12%, n=3 - Initial Investment = 42,600x 2.4018 + (10,000 +7,000) x 0.7118 - ( 90,000 + 10,000) = $ 102,316.68 + $ 12,100.60 - $ 100,000 = $ 14,417.28

$ Sales revenue 120,000 Costs 72,000 Depreciation expense 30,000 Income before taxes 18,000 Tax @ 30% 5,400 Net income 12,600 Depreciation expense 30,000 Net annual cash inflows 42,600

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