9.Quad Enterprises is considering a new three-year expansion project that requir
ID: 2760800 • Letter: 9
Question
9.Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.43 million. The fixed asset will be depreciated straight-line over its three-year tax life, and the fixed asset will have a market value of $281289 at the end of the project. The project is estimated to generate $2102812 in annual sales, with costs of $805313. The project requires an initial investment in net working capital of $361924. If the tax rate is 37 percent and the required return on the project is 11 percent, what is the project's NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to the nearest dollar amount. Omit the "$" sign and commas in your response. For example, $123,456.78 should be entered as 123457.)
Explanation / Answer
Solution:
(i) Present Value of Cash Outflow (Cost of Project)
Investment Amount
$2,430,000
Add: Working Capital requirement
$361,924
Present Value of Cash Outflow
$2,791,924
(ii) Present Value of Cash Flows
Estimated Annual Sales
$2,102,812
Less: Cost of Sales
($805,313)
Profit Before tax and depreciation
$1,297,499
Less: Depreciation (Note 1)
($716,237)
Profit Before Tax
$581,262
Less: Taxes @ 37%
($215,067)
Profit After Tax
$366,195
Add: Depreciation
$716,237)
Annual Cash Flow
$10,82,432
Present Value Interest factor for Annuity (11%, 3)
2.4437
Present Value of Cash Flow ($10,82,432 x 2.4437)
$2,645,155
Add: Present Value of Salvage Value at the end of life after tax (0.73119 x $281,289 x (1-0.37)]
$129,576
Add: Present Value of Working Capital Released at the end of project life ($361,924 x 0.73119)
$264,635
Total Present Value of Cash Flow ($2,645,155 + $129,576 + $264,635)
$3,039,366
Note 1: Annual Depreciation as per SLM = (Cost of Asset – Scrap Value) / estimated life = ($2,430,000 - $281,289) / 3 = $716,237
Note 2: In case the project requires working capital, then if nothing specify in the question about Working Capital release, then it is assumed that working capital should be released at the end of project life.
Note 3: Salvage Value is taken after tax.
(iii) Net Present Value
Total Present Value of Cash Flow
$3,039,366
Less: Present Value of Cash Outflow
($2,791,924)
Net Present Value (NPV)
$247,442
Investment Amount
$2,430,000
Add: Working Capital requirement
$361,924
Present Value of Cash Outflow
$2,791,924
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