Quad Enterprises is considering a new three-year expansion project that requires
ID: 2711121 • Letter: Q
Question
Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.49 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,010,000 in annual sales, with costs of $705,000. The project requires an initial investment in net working capital of $230,000, and the fixed asset will have a market value of $295,000 at the end of the project. If the tax rate is 34 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? If the required return is 11 percent, what is the project's NPV?
Explanation / Answer
Year 0 net cash flow = -initial fixed asset investment - initial investment in net working capital
Year 0 net cash flow = -2490000 -230000
Year 0 net cash flow = - 2720000
Annual Depreciation = Fixed Asset cost/useful life
Annual Depreciation = 2490000/3
Annual Depreciation = 830000
Year 1 net cash flow = (annual sales -cost)*(1-tax rate) + Annual Depreciation *tax rate
Year 1 net cash flow = (2010000-705000)*(1-34%) + 830000*34%
Year 1 net cash flow = 1143500
Year 2 net cash flow = (annual sales -cost)*(1-tax rate) + Annual Depreciation *tax rate
Year 2 net cash flow = (2010000-705000)*(1-34%) + 830000*34%
Year 2 net cash flow = 1143500
Year 3 net cash flow = (annual sales -cost)*(1-tax rate) + Annual Depreciation *tax rate + Posttax salvage Value + Working Capital realised back
Year 3 net cash flow = (2010000-705000)*(1-34%) + 830000*34% + 295000*(1-34%) + 230000
Year 3 net cash flow = 1568200
Project's NPV = -Year 0 net cash flow + Year 1 net cash flow/(1+required rate) + Year 2 net cash flow/(1+required rate)^2 + Year 3 net cash flow/(1+required rate)^3
Project's NPV = -2720000 + 1143500/1.11 + 1143500/1.11^2 + 1568200/1.11^3
Project's NPV = $ 384,924.76