Quad Enterprises is considering a new three-year expansion project that requires
ID: 2741131 • Letter: Q
Question
Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.4 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $1,980,000 in annual sales, with costs of $675,000. The project requires an initial investment in net working capital of $200,000, and the fixed asset will have a market value of $310,000 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?
Explanation / Answer
Annual Depreciation Charge on the project = $ 2.4 million/3 = $ 2,400,000 / 3 = $ 800,000
Annual Sales = $1,980,000
Annual Costs = $675,000
Annual Gross Profit = Sales - Costs = $1,980,000 - $675,000 = $ 1,305,000
Annual Taxable Profit = Gross Profit - Depreciation = $ (1,305,000 - 800,000) = $ 505,000
Tax Paid = 34% of $ 505,000 = $ 171,700
Annual Net Profit after Tax = Taxable Profit - Tax paid = $ (505,000 - 171,700) = $ 333,300
Annual Cash Inflow after Tax = Net Profit + Depreciation = $ (333,300 + 800,000) = $ 1,133,300
Net Cash Flows:
Year 0 = - ($ 2,400,000 + $ 200,000) = - ($ 2,600,000) (Outflow for initial investment on fixed asset and working capital)
Year 1 = $ 1,133,300 (Inflow)
Year 2 = $ 1,133,300 (Inflow)
Year 3 = $ 1,133,300 (Inflow) + $ 310,000 (Inflow from Scrap Value) + $ 200,000 (Inflow from Release of Working Capital) = $ 1,643,300 (Inflow)