Summer Tyme, Inc., is considering a new three-year expansion project that requir

Question

Summer Tyme, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $3.9 million. The fixed asset falls into the three-year MACRS class (MACRS Table) and will have a market value of $210,000 after three years. The project requires an initial investment in net working capital of $300,000. The project is estimated to generate $2,650,000 in annual sales, with costs of $840,000. The tax rate is 35 percent and the required return on the project is 12 percent. The net cash flow in Year 0,1,2,3 and the NPV?

Explanation / Answer

Answer:

A) Calculation of Initial Cash Outflow requirement for Project (at year 0)

B) Calculation of Depreciation to be charged each year (MACRS Table)

Initial Cost of Fixed Assets = $3,900,000

Life of Fixed Assets = 3 Years

Salvage Value of Fixed Assets at end of three years = $210,000

Depreciation (As per Staraight line method) = ($3,900,000 - $210,000) / 3 = $1,230,000

Depreciation Amount as per MACRS Table

MACRS method is converted into straight line method when that method provides an equal or greater deduction.

In the above table year 3 depreciation rate in MACRS table is 14.81%. The depreciation as per MACRS table comes $1,444,372 x 14.81% = $213,911 which is less than straight line depreciation $1,230,000 hence in year 3 straight line depreciation is considered..

C) Calcuation of Present Value of Cash Flows

D) Calculation of Net Present Value

PV of Cash Flow (from C) = $4,171,930

Less: PV of Cash Outflow = ($4,200,000)

Net Present Value = -$28,070

Notes:

1) Salvage Value is considered after tax at end of year 3.

2) Since at initial stage working capital is required. It is released at the end of year 3.

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