Cochrane, Inc., is considering a new three-year expansion project that requires
ID: 2624616 • Letter: C
Question
Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,340,000. 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 $2,230,000 in annual sales, with costs of $1,220,000. The project requires an initial investment in net working capital of $158,000, and the fixed asset will have a market value of $183,000 at the end of the project. Assume that the tax rate is 40 percent and the required return on the project is 9 percent.
What are the net cash flows of the project for the following years 0,1,2,3
Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,340,000. 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 $2,230,000 in annual sales, with costs of $1,220,000. The project requires an initial investment in net working capital of $158,000, and the fixed asset will have a market value of $183,000 at the end of the project. Assume that the tax rate is 40 percent and the required return on the project is 9 percent.
Explanation / Answer
Hi,
Please find the detailed answer as follows:
Initial Investment = -2340000 - 158000 = -2498000
Annual Cash Inflows = (Annual Sales - Annual Costs - Depreciation)*(1-Tax Rate) + Depreciation = (2230000 - 1220000 - 2340000/3)*(1-40%) + 2340000/3 = 918000
Requirement 1:
Cash Flow Year 1 = 918000
Cash Flow Year 2 = 918000
Cash Flow Year 3 = 918000 + 158000 (Recovery of Working Capital) + 183000*(1-.40) (Market Value after Tax) = 1185800
Requirement 2:
NPV = -2498000 + 918000/(1+.09)^1 + 918000/(1+.09)^2 + 1185800/(1+.09)^3 = 32519.24 or 32519
Thanks.