Cochrane, Inc., is considering a new three-year expansion project that requires
ID: 2742457 • Letter: C
Question
Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $1,680,000. 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 $1,950,000 in annual sales, with costs of $1,060,000. Assume the tax rate is 34 percent and the required return on the project is 14 percent. Required: What is the project’s NPV? (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567). Round your answer to 2 decimal places (e.g., 32.16).)
Net present value
Explanation / Answer
We have to calculate the operating cash flows from the project and then discount all cash outlows and OCF using the 14% discount rate.
Depreciation per year = cost of the asset/useful life = 1,680,000/3 = $560,000
Operating cash flow = EBIT (earnings before interest and taxes)+depreciation-taxes
EBIT = Sales - costs-Depreciation.
Calculation of operating cash flows:
Discount factor for year 1 = 1/1.14 = 0.8772. Discount factor for year 2 = 1/1.14^2 = 0.7695. Discount factor for year 3 = 1/1.14^3 = 0.6750
Present value = Cash flow*discount factor. NPV = sum of all Present values.
Present values and NPV:
Thus NPV = $125,765.39
Year 1 Year 2 Year 3 Revenue 1,950,000.00 1,950,000.00 1,950,000.00 less: costs 1,060,000.00 1,060,000.00 1,060,000.00 less: depreciation 560,000.00 560,000.00 560,000.00 EBIT 330,000.00 330,000.00 330,000.00 Tax @ 34% of EBIT 112,200.00 112,200.00 112,200.00