Consider an investment of $500,000 at time zero for machinery and equipment to b
ID: 1224142 • Letter: C
Question
Consider an investment of $500,000 at time zero for machinery and equipment to be depreciated using 8 year straight line depreciation starting in year 1 to year 8. Annual revenue is estimated to be $400,000 and annual operating costs of $180,000. $200,000 for working capital investment is also needed at time zero and working capital return is expected to equal the initial working capital investment at the end of the project (8th year). Salvage value of the machinery and equipment is expected to be zero. The minimum After Tax Cash Flow ROR is 12% and the effective income tax rate is 38%. Calculate After Tax Cash Flow and NPV project life.
Explanation / Answer
Cash flow (CF) for 0 year = Investment + Working capital
= 500,000 + 200,000
= 700,000
CF for 1 to 7 year = Revenues – Operating costs
= 400,000 – 180,000
= 220,000
CF for 8th year = Revenues – Operating cost + Working capital
= 400,000 – 180,000 + 200,000
= 420,000
CF after tax for 1 to 7 year = CF × (1 – tax rate)
CF after tax for 8th year = (Revenues – Operating cost) × (1 – tax rate) + Working capital
Net cash flow (NCF) = CF after tax + Depreciation
Depreciation = Investment / year = 500,000 / 8 = 62,500
The required table is as below:
Year
CF
CF after tax
NCF
12% rate factors
PV = NCF × factors
0
-700,000
-700,000
-700,000
1
-700,000
1
220,000
136,400
198,900
0.8929
177,597.81
2
220,000
136,400
198,900
0.7972
158,563.08
3
220,000
136,400
198,900
0.7118
141,577.02
4
220,000
136,400
198,900
0.6355
126,400.95
5
220,000
136,400
198,900
0.5674
112,855.86
6
220,000
136,400
198,900
0.5066
100,762.74
7
220,000
136,400
198,900
0.4523
89,962.47
8
420,000
336,400
398,900
0.4039
161,115.71
NPV
368,835.64
NPV is $368,835.64
Year
CF
CF after tax
NCF
12% rate factors
PV = NCF × factors
0
-700,000
-700,000
-700,000
1
-700,000
1
220,000
136,400
198,900
0.8929
177,597.81
2
220,000
136,400
198,900
0.7972
158,563.08
3
220,000
136,400
198,900
0.7118
141,577.02
4
220,000
136,400
198,900
0.6355
126,400.95
5
220,000
136,400
198,900
0.5674
112,855.86
6
220,000
136,400
198,900
0.5066
100,762.74
7
220,000
136,400
198,900
0.4523
89,962.47
8
420,000
336,400
398,900
0.4039
161,115.71
NPV
368,835.64