Cochrane, Inc., is considering a new three-year expansion project that requires
ID: 2742508 • 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. The project requires an initial investment in net working capital of $150,000, and the fixed asset will have a market value of $175,000 at the end of the project. Assume that the tax rate is 34 percent and the required return on the project is 14 percent.
What are the net cash flows of the project for the following years?
What is the NPV of the project?
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. The project requires an initial investment in net working capital of $150,000, and the fixed asset will have a market value of $175,000 at the end of the project. Assume that the tax rate is 34 percent and the required return on the project is 14 percent.
Explanation / Answer
1. Computation of net cash flows of the project:
2. Computation of NPV of the project:
Year Calculation Cashflow 0 Initial investment + changes in net working capital = $1,680,000+$150,000 ($1,830,000) 1 Cash flow = {(sales - cost - depreciation) - tax} + depreciation={($1,950,000 - $1,060,000 - ($1,680,000 / 3years)) - 34%} + 560,000 $777,800 2 Cash flow = {(sales - cost - depreciation) - tax} + depreciation
={($1,950,000 - $1,060,000 - ($1,680,000 / 3years)) - 34%} + 560,000 $777,800 3 Cash flow = {(sales - cost - depreciation + salvage value) - tax} + depreciation
={($1,950,000 - $1,060,000 - ($1,680,000 / 3years) + 175,000) - 34%} + 560,000 $893,000