Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.79 million.

Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.79 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 $2,110,000 in annual sales, with costs of $805,000. The tax rate is 35 percent and the required return on the project is 12 percent. What is the project’s NPV? (Enter your answer in dollars, not millions of dollars, e.g. 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

NPV

$

 

Explanation:

Using the tax shield approach to calculating OCF (Remember the approach is irrelevant; the final answer will be the same no matter which of the four methods you use.), we get:

OCF = (Sales − Costs)(1 − TC) + TC(Depreciation)

OCF = ($2,110,000 − 805,000)(1 − .35) + .35($2,790,000 / 3)

OCF = $1,173,750

Since we have the OCF, we can find the NPV as the initial cash outlay plus the PV of the OCFs, which are an annuity, so the NPV is:

NPV = −$2,790,000 + $1,173,750(PVIFA12%,3)

NPV = $29,149.45

A firm evaluates all of its projects by applying the NPV decision rule. A project under consideration has the following cash flows:

Problem 9-8 Calculating NPV [LO1]

A firm evaluates all of its projects by applying the NPV decision rule. A project under consideration has the following cash flows:

  

Year	Cash Flow
0	–$	28,600
1		12,600
2		15,600
3		11,600

  

What is the NPV for the project if the required return is 11 percent? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

NPV

$

  

At a required return of 11 percent, should the firm accept this project?

Yes

  

What is the NPV for the project if the required return is 25 percent? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

NPV

$

  

At a required return of 25 percent, should the firm accept this project?

No

 

Explanation:

The NPV of a project is the PV of the inflows minus the PV of the outflows. The equation for the NPV of this project at an 11 percent required return is:

NPV = –$28,600 + $12,600 / 1.11 + $15,600 / 1.112 + $11,600 / 1.113 = $3,894.48

At an 11 percent required return, the NPV is positive, so we would accept the project.

The equation for the NPV of the project at a required return of 25 percent is:

NPV = –$28,600 + $12,600 / 1.25 + $15,600 / 1.252 + $11,600 / 1.253 = –$2,596.80

At a required return of 25 percent, the NPV is negative, so we would reject the project.

  

Calculator Solution:

Note: Intermediate answers are shown below as rounded, but the full answer was used to complete the calculation.

    

	CFo	–$28,600	CFo	–$28,600
	C01	$12,600	C01	$12,600
	F01	1	F01	1
	C02	$15,600	C02	$15,600
	F02	1	F02	1
	C03	$11,600	C03	$11,600
	F03	1	F03	1
	I = 11%		I = 25%
	NPV CPT		NPV CPT
	$3,894.48		–$2,596.80