Quad Enterprises is considering a new three-year expansion project that requires
ID: 2729849 • Letter: Q
Question
Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.79 million. The fixed asset falls into the three-year MACRS class. The project is estimated to generate $2,110,000 in annual sales, with costs of $799,000. The project requires an initial investment in net working capital of $330,000, and the fixed asset will have a market value of $225,000 at the end of the project. If the tax rate is 35 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (MACRS schedule) (Enter your answers in dollars, not millions of dollars, e.g. 1,234,567. Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places, e.g., 32.16.) If the required return is 12 percent, what is the project's NPV? (Enter your answer in dollars, not millions of dollars, e.g. 1,234,567. Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.)Explanation / Answer
The asset will be depreciatied using the MACRS rate for a 3 year asset: 33.33% (year 1), 44.45% (year 2), 14.81% (year 3) and 7.41% (year 4).
Depreciation amount = cost of asset (i.e. $2.79 million*applicable rate for the relevant year).
Projected income statement:
Using the above income statement, we will now determine operating cash flows:
We will now consider the non operating cash flows. Initial investment in Net working capital = 330,000 and i am assuming that this amount will be recovered back at the end of the project.
Initial investment = 2.79 million or $2,790,000. Book value at the end of 3rd year = 206,739 (as shown in the depreciation table). Market value = 225,000. After tax salvage value = 225,000 - 35%*(225,000-206,739) = $218,608.65
Thus projected cash flows are:
Now, NPV with r = 12%.
= -3,120,000 + 1,177,617.45/(1.12^1)+1,286,204.25/(1.12^2)+1,545,378.30/(1.12^3)
[formula: present value = cach flow amount/(1+r)^t]
NPV = sum of all present values
Year MACRS % Cost of asset Depreciation Ending book value 1 33.33% 2,790,000.00 929,907.00 1,860,093.00 2 44.45% 1,240,155.00 619,938.00 3 14.81% 413,199.00 206,739.00 4 7.41% 206,739.00 0.00