Quad Enterprises is considering a new three-year expansion project that requires
ID: 2340560 • Letter: Q
Question
Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.28 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $1,750,000 in annual sales, with costs of $660,000. The project requires an initial investment in net working capital of $330,000, and the fixed asset will have a market value of $300,000 at the end of the project. a. If the tax rate is 23 percent, what is the project's Year O net cash flow? Year 1? Year 2? Year 3? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, e.g., 1,234,567. A negative answer should be indicated by a minus sign.) b. If the required return is 12 percent, what is the project's NPV? (Do not round intermediate calculations and round your answer to 2 decimal places,e.g., 32.16.) a. Year 0 cash flow Year 1 cash flow Year 2 cash flow Year 3 cash flow b. NPVExplanation / Answer
a) year 0 cash flow: -$2,610,000
Year 1 cash flow: $1,014,100
Year 2 cash flow: $1,014,100
Year 3 cash flow: $1,644,100
Explaination-
Cashflow for Year 0:
As there are no sales and only initial investment will be done in Year 0, there will be a cash outflow that is equal to initial investment.
Initial investment = Fixed asset + Net working capital
Initial investment = $2,280,000 + 330,000 = $2,610,000
So, cashflow in Year 0 = -$2,610,000
Fixed Asset is depreciated to 0 in 3 years using straight-line depreciation.
Depreciation per year = 2,280,000 / 3 = $760,000
Cash flow for Year 1 and 2:
Sales = $1,750,000
Cost = $660,000
Gross profit = Sales - Cost = $1,090,000
Depreciation = $760,000
EBIT = Gross profit - Depreciation = $330,000
Interest = 0
Tax rate = 23%
Net Income = 330,000 (0.77) = $254,100
Now, we know that depreciation is a non cash expense.
So, Cash inflow for Year 1 and 2 = 254,100 + 760,000 = $1,014,100
Cash flow for Year 3:
Net income will remains same as $254,100.
We will add depreciation expense of $760,000.
We will add the market value of the asset as $300,000.
We will add back the working capital of $330,000.
Cash inflow in Year 3 = 254,100 + 760,000 + 300,000 + 330,000 = $1,644,100
Part b)
The NPV of the project is $274,117.81
Explaination:
We will discount the cash flows to year 0 to find the NPV of project
r = 12%
NPV = 2,610,000+1,014,100/(1+0.12)^1+1,014,100/(1+0.12)^2+1,644,100/(1+0.12)^3
NPV = $274,117.81
So, the NPV of the project is $274,117.81