Cochrane, Inc., is considering a new three-year expansion project that requires
ID: 2685344 • Letter: C
Question
Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.40 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 $2,250,000 in annual sales, with costs of $1,240,000. The project requires an initial investment in net working capital of $160,000, and the fixed asset will have a market value of $185,000 at the end of the project. Assume that the tax rate is 30 percent and the required return on the project is 10 percent. Requirement 1: What are the net cash flows of the project for the following years? (Do not include the dollar signs ($). Negative amounts should be indicated by a minus sign. Enter your answers in dollars, not millions of dollars (e.g., 1,234,567).) Year Cash Flow 0 $ 1 2 3 Requirement 2: What is the NPV of the project?Explanation / Answer
Cash flow 0 will be the cost of project and the investment in working capital which was: 2,310,000 + 157,000 = 2,467,000 but since this is a cash outflow its negative so its -2,467,000 Each cash flow would be: Sales - costs - depreciation = pretax income pretax income x (1-t) = net income net income + depreciation = cash flow which is 2220000-1210000-770000=240000 adjusted for taxes its 168000. since depreciation is a NON cash expense we must adjust cash flow by adding to back TO net income. 168,000+770,000 = 938,000 which is the cash flow for year 1 and 2. for year 3, we have a cash from operations of 938,000 but we also sell the piece of equipment which generates a cash flow and we get our net working capital back. We must adjust for these. We sell the equipment for 182,000 but it has a book value of zero (problem says we depreciate it TO zero.) because we sold for more than book value we must get taxed on that gain of 182,000 so we must tax at 30% and we are left with 127,400. we also get back 157,000 in net working capital. Therefore net cash flow in year 3 is 938,000+127,400+157,000 = 1,222,400