Quad Enterprises is considering a new three-year expansion project that requires
ID: 2715135 • Letter: Q
Question
Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.67 million. The fixed asset will be depreciated straight-line over its three-year tax life, and the fixed asset will have a market value of $296922 at the end of the project. The project is estimated to generate $2044108 in annual sales, with costs of $899932. The project requires an initial investment in net working capital of $368006. If the tax rate is 35 percent and the required return on the project is 12 percent, what is the project's Year 0 net cash flow?
Explanation / Answer
Step -1 calculation of initial investments
Assets cost = $ 2670000
Working Capital = $ 368006
Total Initial Investments = $ 3038006
Step- 2 Calculation of PV of Post Tax annual cash flows
Annual Sales = $ 2044108
(-) Costs = $ 899932
Annual Profit = $ 1144176
(-) Taxes @ 35% = $ 400462 (Rounded off)
Annual Post Tax Profit = $ 743714
PV of Expected Profit from Project= $ 1786276
Step- 3 Calculation of Post tax Salvage value
Book Value of Assets After 3 Years= Nil
Salvage Value = $ 296922
Capital gain tax on Salvage Value =$ 103923
therefore, Post tax Salvage Value = $192999
PV of Post tax Salvage Value = $ 137373
Therefore, Net cash flow at T=0 (Step 2+3-1) = $ 1786276+137373-3038006
=($ 1114357)
Since the net cash flow of the project is negative the investment should not be made.