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 $2.64 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,060,000 in annual sales, with costs of $755,000. The tax rate is 35 percent and the required return is 13 percent. The project requires an initial investment in net working capital of $280,000, and the fixed asset will have a market value of $270,000 at the end of the project.

Explanation / Answer

NPV is possitive so Project shoud be accepted.

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Calculation of depreciation tax shield year 1 2 3 Depreciation basis 2640000 2640000 2640000 Depreciation rate 1/3 33.33% 33.33% 33.33% Depreciation 879912 879912 879912 ( x )tax rate 30% 30% 30% 30% Depreciation Tax shield 263973.6 263973.6 263973.6 Calculation of net salvage value Book value =0 Net salvage value = salvage value + (Book value – book value) x tax rate 270,000+(0-270,000)*35% $175500 Calculation of Cash flows Year 0 1 2 3 initial cost of investment -2640000 Sales revenue 2060000 2060000 2060000 (-) cost of sales -755000 -755000 -755000 EBIT 1305000 1305000 1305000 (-) taxes 35% -456750 -456750 -456750 Cash income 848250 848250 848250 Depreciation tax benefit 263973.6 263973.6 263973.6 net salvage value 175500 Working capital -280000 0 0 280000 Net Cash flows -2920000 1112223.6 1112223.6 1567723.6 Calculation of net present value year Cash flow PV factor 13% PV 0 -2920000 1 -2920000.00 1 1112223.6 0.88496 984273.40 2 1112223.6 0.78315 871037.91 3 1567723.6 0.69305 1086510.84 NPV $ 21,822.15 NPV = $21,822.15 Note: Working Capital is invested in Year 0 and recovered after tax in the end of year.

NPV is possitive so Project shoud be accepted.

Market Value after tax=$ 175500

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