A proposed investment has an equipment cost of $1380800. The cost will be deprec
ID: 2783619 • Letter: A
Question
A proposed investment has an equipment cost of $1380800. The cost will be depreciated straight line to a zero salvage value over its 15 year life. The firm will also use their existing, but currently unused, equipment that has been fully depreciated but has a market value of $37000. Cash sales will be $223690 per year and variable cost will run $98469 per year. Fixed cost is $56400 per year. The firm will also need to invest $45331 in net working capital. marketing research for this project was $46500 last year and on going marketing ads will cost $7000 per year. The appropriate discount rate is 7.4% and the corporate marginal tax rate is 33% while the average tax rate is 36%.
What is the NPV?
Explanation / Answer
The cost of equipment FCinv $1380800 and the firm will need to invest WCinv $45331 in net working capital
Thus initial cash outflow = FCinv + WCinv
=1380800+45331
=1,426,131
We will also add one time marketing research cost of $46500 to the inital cash outflow but will not add the existing machine as its not creating any cashflow
thus 1426131+ 46500 = 1472631
Here given,
Sales = 223690
cost= variable cost + fixed cost + marketing ads cost = 98469+56400+7000 = 161,869
Depreciation = 1380800/15 = 92053.34 (as it will be depreciated to zero over 15 years life)
After tax operating cashflow = (sales-cost)*(1-tax)+(tax*depreciation)
=(223690-161869)(1-0.36)+(0.36*92053.34)
=61821(0.64)+33139.20
=39565.44+33139.20
CF =72704.64
Here the salvage value is zero and the final year book value is also zero as it is depreciated to zero
Terminal year after tax non operating cashflow = Salvage + WCinc - tax (salvage - book value)
TNOCF =0+45331-0.36(0-0)
TNOCF =45331
We can calculate NPV by inserting CFs in the financial calulator as per the spreadsheet and pressing CPT and then NPV using 7.4% discount rate
Lets calculate NPV as show below spreadsheet:
Year
Cashflows
0
-1472631
1
72704.64
2
72704.64
3
72704.64
4
72704.64
5
72704.64
6
72704.64
7
72704.64
8
72704.64
9
72704.64
10
72704.64
11
72704.64
12
72704.64
13
72704.64
14
72704.64
15
118035.64
Final year cashflow = CF+TNOCF
NPV
-$755,417.17
Using formula for NPV at 7.4% discount rate
Year
Cashflows
0
-1472631
1
72704.64
2
72704.64
3
72704.64
4
72704.64
5
72704.64
6
72704.64
7
72704.64
8
72704.64
9
72704.64
10
72704.64
11
72704.64
12
72704.64
13
72704.64
14
72704.64
15
118035.64
Final year cashflow = CF+TNOCF
NPV
-$755,417.17
Using formula for NPV at 7.4% discount rate
The NPV for the project is negative and thus one would not like to accept and invest in the project.Related Questions
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