Cochrane, Inc., is considering a new three-year expansion project that requires

Question

Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,670,000. 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 $2,340,000 in annual sales, with costs of $1,330,000. The project requires an initial investment in net working capital of $169,000, and the fixed asset will have a market value of $194,000 at the end of the project. Assume that the tax rate is 30 percent and the required return on the project is 6 percent. What are the net cash flows of the project for the years 0, 1, 2, and 3? What is the NPV of the project?

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Part A:

Initial Investment = -2670000 - 169000 = -2839000

Annual Cash Inflow = (Sales - Cost - Depreciation)*(1-Tax Rate) + Depreciation = (2340000 - 1330000 - 2670000/3)*(1-.30) + 2670000/3 = 974000

Terminal Year Cash Flow (Year 3) = Annual Cash Inflow + Recovery of Working Capital + Market Value*(1-Tax Rate) = 974000 + 169000 + 194000*(1-.30) = 1278800

Table of Cash Flows:

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Part B:

NPV = -2839000 + 974000/(1+.06)^1 + 974000/(1+.06)^2 + 1278800/(1+.06)^3 = $20429.60

Thanks.

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