Quad Enterprises is considering a new three-year expansion project that requires
ID: 2731223 • Letter: Q
Question
Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.43 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $1,990,000 in annual sales, with costs of $685,000. The project requires an initial investment in net working capital of $210,000, and the fixed asset will have a market value of $305,000 at the end of the project. If the tax rate is 30 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (Do not round intermediate calculations. Enter your answers in dollars, not millions of dollars, e.g. 1,234,567. Negative amounts should be indicated by a minus sign.) If the required return is 18 percent, what is the project's NPV? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.)
Explanation / Answer
Initial investment = $60,000
Annual depreciation = Cost of investment/Useful life = $2,430,000/3 = $810,000
Annual net income before tax = Annual sales – Annual costs = $1,990,000 - $685,000 = $1,305,000
Annual net income = $1,305,000 * (1 – 0.30) = $913,500
Tax savings on depreciation = $810,000 * 0.30 = $243,000
Annual free cash flows = Annual net income + Tax savings on depreciation = $913,500 + $243,000 = $1,156,500
Market value of fixed asset at the end of project = $305,000
After tax receipts on sale of fixed assets = $305,000 * 0.70 = $213,500
Year 0 Cash flows = Initial investment + Net working capital investment = $2,430,000 + $210,000 = -$2,640,000
Year 1 and Year 2 cash flows = $1,156,500
Year 3 cash flows = Annual free cash flows + Receipt on sale of fixed assets + Release of net working capital investment = $1,156,500 + $213,500 + $210,000 = $1,580,000
Year
Cash flows
Present vaue factor @ 18%
Present value of cash flows
0
-$ 2,640,000.00
1
-$ 2,640,000.00
1
$ 1,156,500.00
0.8475
$ 980,133.75
2
$ 1,156,500.00
0.7182
$ 830,598.30
3
$ 1,580,000.00
0.6086
$ 961,588.00
$ 132,320.05
Net present value = $132,320.05
Year
Cash flows
Present vaue factor @ 18%
Present value of cash flows
0
-$ 2,640,000.00
1
-$ 2,640,000.00
1
$ 1,156,500.00
0.8475
$ 980,133.75
2
$ 1,156,500.00
0.7182
$ 830,598.30
3
$ 1,580,000.00
0.6086
$ 961,588.00
$ 132,320.05