Cochrane, Inc., is considering a new three-year expansion project that requires
ID: 2632035 • Letter: C
Question
Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.01 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 $2,120,000 in annual sales, with costs of $1,110,000. The project requires an initial investment in net working capital of $163,000, and the fixed asset will have a market value of $188,000 at the end of the project. Assume that the tax rate is 34 percent and the required return on the project is 15 percent.
What is the project's Year 0 net cash flow?
What is the project's Year 1 net cash flow?
What is the NPV of the project?
What is the project's Year 0 net cash flow?
What is the project's Year 1 net cash flow?
What is the project's Year 2 net cash flow? What is the project's Year 3 net cash flow?What is the NPV of the project?
Explanation / Answer
Annual depreciation = initial investment / 3 = 2,010,000 / 3 = 670,000
Year 0 cash flow = - initial investment - net working capital = - 2,010,000 - 163,000 = -2,173,000
Year 1 cash flow = (sales-costs) * (1-tax rate) + depreciation * tax rate = (2,120,000-1,110,000) * (1-34%) + 670,000 * 34% = 894,400
Year 2 cashflow = year 1 cashflow = 894,400
Year 3 cashflow = year 2 cashflow + recovery of net working capital + fixed asset market value * (1-tax rate) = 894,400 + 163,000 + 188,000 * (1-34%) = 1,181,480
NPV = -2,173,000 + 894,400/1.15^1 + 894,400/1.15^2 + 1,181,480/1.15^3 = 57,876.30
Hope this helped ! Let me know in case of any queries.