Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.4 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $1,980,000 in annual sales, with costs of $675,000. The project requires an initial investment in net working capital of $200,000, and the fixed asset will have a market value of $310,000 at the end of the project. If the tax rate is 34 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (Do not round intermediate calculations. Enter your answers in dollars, not millions of dollars, e.g. 1,234,567. Negative amounts should be indicated by a minus sign.)
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If the required return is 18 percent, what is the project's NPV? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.)
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rev: 11_04_2015_QC_CS-32334
Explanation:
| The Year 0 cash flow is: |
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| Year 0 = −$2,400,000 − 200,000 = –$2,600,000 |
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The cash outflow at the beginning of the project will increase because of the spending on NWC. At the end of the project, the company will recover the NWC, so it will be a cash inflow. The sale of the equipment will result in a cash inflow, but we also must account for the taxes that will be paid on this sale. So, the cash flows for each year of the project will be:
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| OCF = (Sales − Costs)(1 − TC) + TC(Depreciation) |
| OCF = ($1,980,000 − 675,000)(1 − .34) + .34($2,400,000 / 3) |
| OCF = $1,133,300 |
| In Years 1 and 2, the only cash flow is the OCF. In Year 3, the total cash flow will include the recovery of the NWC and the aftertax salvage value, so: |
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| Year 3 = $1,133,300 + 200,000 + 310,000 + ($0 − 310,000)(.34) |
| Year 3 = $1,537,900 |
| And the NPV of the project is: |
| NPV = −$2,600,000 + $1,133,300(PVIFA18%,2) + ($1,537,900 / 1.183) |
NPV = $110,355.56
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