Down Under Boomerang, Inc., is considering a new three-year expansion project th
ID: 2743620 • Letter: D
Question
Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.79 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which it will be worthless. The project is estimated to generate $2,110,000 in annual sales, with costs of $805,000. The tax rate is 35 percent and the required return is 12 percent.
What is the project’s NPV? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)Explanation / Answer
Answer:
Using Tax shield approach to calculating OCF:
OCF= (sales- Costs)(1-tax) + tax*Depreciation
OCF= ($2,110,000- $805,000) (1-0.35) +0.35($2,790,000/3)
OCF= $848,250 +$325,500
OCF =$1,173,750
So NPV of the Project is:
NPV= - $2,790,000 + $1,173,750*PVIFA(12%, 3)
NPV = - $2,790,000 + $1,173,750 * 2.4018
NPV = - $2,790,000 + $2,819,112.75
NPV = $29,112.75
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