24. Maple Media is considering a proposal to enter a new line of business. In re

Question

24. Maple Media is considering a proposal to enter a new line of business. In reviewing the proposal, the company's CFO is considering the following facts: The new business will require the company to purchase additional fixed assets that will cost S600,000 at t -0. For tax and accounting purposes, these costs will be depreciated on a straight-line basis over three years. (Annual depreciation will be $200,000 per year at t-1,2, and 3.) At the end of three years, the company will get out of the business and will sell the fixed assets at a salvage value of $100,000. . The project will require a $50,000 increase in net operating working capital at t-o, which will be recovered at 3.

Explanation / Answer

Answer: Option [B] $536,697

Calculation:

INITIAL INVESTMENT: Cost of fixed assets $      600,000 Increase of NWC $        50,000 Total initial investment $      650,000 ANNUAL OPERATING CASH FLOWS: Sales $ 2,000,000 Operating costs other than depreciation $ 1,400,000 Depreciation $      200,000 EBIT $      400,000 Tax at 35% $      140,000 NOPAT $      260,000 Add: Depreciation $      200,000 OCF $      460,000 TERMINAL NON OPERATING CASH FLOWS: After tax salvage value of fixed assets = 100000*65% = $        65,000 Release of NWC $        50,000 Terminal non operating cash flows $      115,000 NPV: PV of annual OCF = 460000*(1.12^3-1)/(0.12*1.12^3) = $ 1,104,842 PV of terminal cash flow = 115000/1.12^3 = $        81,855 PV of cash inflows $ 1,186,697 Less: Initial investment $      650,000 NPV $      536,697

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