Quad Enterprises is considering a new three-year expansion project that requires
ID: 2741149 • Letter: Q
Question
Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.82 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 $2,120,000 in annual sales, with costs of $815,000. The project requires an initial investment in net working capital of $340,000, and the fixed asset will have a market value of $230,000 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?
If the required return is 12 percent, what is the project's NPV?
Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.82 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 $2,120,000 in annual sales, with costs of $815,000. The project requires an initial investment in net working capital of $340,000, and the fixed asset will have a market value of $230,000 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?
If the required return is 12 percent, what is the project's NPV?
Explanation / Answer
Quad enterprise projects NPV
Initial investment $2,820,000
Sales $2,120,000
Cost $815,000
Depreciation $940,000
From the above data EBIT can be calculated which will come to - $365,000, less tax@ 30% for Net income
Net income = $255,500
Now calculating Operating Cash Flow (OCF)= Net income + depreciation
OCF = $1,195,500
The cash outflow at the beginning of the project will increase because of the spending on Net Working Capital. At the end of the project, the firm will recover the Net Working Capital investment, so it will be a cash inflow in year 3. The sale of the equipment will result in a cash inflow, but we also must account for the taxes which will be paid on the gain of this sale
NPV of the project @12%
= -3160000 + PV of CF1 1067410.71 + PV of CF2 953045.28 + PV of CF3 1207535.19
= $67,991.18
Years cash flow 0 $ -3,160,000 (-2820000-340000) 1 $ 1,195,500 2 $ 1,195,500 3 $1,696,500 (1,195,500+$340,000+$230,000-$230,000x0.30)