ABC Corporation is considering an expansion project. To date they have spent $15
ID: 2707475 • Letter: A
Question
ABC Corporation is considering an expansion project. To date they have spent $150,000 investigating the viability of the project and have decided to proceed. The proposed project will cost $1,500,000 in addition to the $150,000 that was spent on the feasibility study. The project will be depreciated over a 3 year MACRS class life.
MACRS
Depreciation
Year Rates
1 0.33
2 0.45
3 0.15
4 0.07
If the project is undertaken the company will need to increase its inventories by $500,000, and its accounts payable will rise by $200,000. The company will realize an additional $1,500,000 in sales over each of the next four years. The company
Explanation / Answer
YEARS
CASHFLOWS AFTER TAX
PRESENT VALUE @ 12%
0
(1500000) + working capital
(1500000+300000)
=(1800000)
(1800000)
1
(1500000-750000-495000)*0.66 + 495000
=663300
592232
2
(1500000-750000-675000)*0.66 + 675000
=724500
577567
3
(1500000-750000-225000)*0.66+ 225000 + sale of project
=571500 + 134700
=706200
502659
4
(1500000-750000)*0.66 + RECOVERY OF WORKING CAPITAL
= 495000 + 300000
=795000
470704
NPV=
343162
CALCULATION OF DEPRECIATION
YEAR -1
1500000*0.33 =495000
YEAR-2
1500000*0.45 =675000
YEAR-3
1500000*0.15 =225000
TOTAL
1395000
NOTE:-
1]COST SPENT ON FEASIBILITY STUDY OF THE PROJECT IS A SUNK COST,THEREFORE IRRELEVANT.
2]CASHFLOW = {SALES-COST-DEPRECIATION]*(1-t) + DEPRECIATION
3]BOOK VALUE OF THE PROJECT AT t =3,
=1500000-1395000
=105000
SALVAGE VALUE OF THE PROJECT AT t = 3, = 150000
Profit ON SALE = 150000-105000
=45000
TAX @ 34% = 45000*0.34
=15300
NET CASHINFLOW FROM SALE OF PROJECT AT t= 3, = 150000
YEARS
CASHFLOWS AFTER TAX
PRESENT VALUE @ 12%
0
(1500000) + working capital
(1500000+300000)
=(1800000)
(1800000)
1
(1500000-750000-495000)*0.66 + 495000
=663300
592232
2
(1500000-750000-675000)*0.66 + 675000
=724500
577567
3
(1500000-750000-225000)*0.66+ 225000 + sale of project
=571500 + 134700
=706200
502659
4
(1500000-750000)*0.66 + RECOVERY OF WORKING CAPITAL
= 495000 + 300000
=795000
470704
NPV=
343162
CALCULATION OF DEPRECIATION
YEAR -1
1500000*0.33 =495000
YEAR-2
1500000*0.45 =675000
YEAR-3
1500000*0.15 =225000
TOTAL
1395000
NOTE:-
1]COST SPENT ON FEASIBILITY STUDY OF THE PROJECT IS A SUNK COST,THEREFORE IRRELEVANT.
2]CASHFLOW = {SALES-COST-DEPRECIATION]*(1-t) + DEPRECIATION
3]BOOK VALUE OF THE PROJECT AT t =3,
=1500000-1395000
=105000
SALVAGE VALUE OF THE PROJECT AT t = 3, = 150000
Profit ON SALE = 150000-105000
=45000
TAX @ 34% = 45000*0.34
=15300
NET CASHINFLOW FROM SALE OF PROJECT AT t= 3, = 150000