(Use these problems to answer Q2.) Quad enterprises is considering a new three-y
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Question
(Use these problems to answer Q2.) Quad enterprises is considering a new three-year expansion project that requires and initial fixed asset investment of $2.9 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,190,000 in annual sale, with costs of $815,000. If the tax rate is 35 percent, what is the OCF for this project? q1. In the previous problem, suppose the required return on the project is 12%. What is the project's NPV? Please show all work. (q2. )In the previous problem, suppose the project requires an initial investment in net working capital of $300,000 and the fixed asset will have a market value of $210,000 at the end of the project. What is the project's year 0 net cash flow. Year 1? Year 2? Year 3? What is the new NPV?
Explanation / Answer
Operating Cash Flow per Year:
Sales: $2,190,000
Less: COGS $815,000
Less: Depreciation $580,000
EBT: $795,000
Less: Tax at 35% $278,250
EAT: $516,750
Add: Depreciation $580,000
OCF: $1,096,750
OCF of the project = $1,096,750 x 3 = $3,290,250
NPV = -$2,900,000 + {$1,096,750/(1+.12)1} + {$1,096,750/(1+.12)2} + {$1,096,750/(1+.12)3}
= -$265,791.55
Net Cash flow for Year 0 = Initial Investment + change in net working capital
= $2,900,000 + $300,000 = $3,200,000
Cash Inflow for year 1 & 2 will not change, so = $1,096,750
Cash Inflow for Year 3 = Operating Cash Flow + After-tax salvage value of machine + Recovery of Net working Capital
NPV = -$3,200,000 + {$1,096,750/(1+.12)1} + {$1,096,750/(1+.12)2} + {$1,533,250/(1+.12)3}
= -255,099.48
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