Middlefield Motors is considering a project that would last for 3 years and have

Question

Middlefield Motors is considering a project that would last for 3 years and have a cost of capital of 17.04 percent. The relevant level of net working capital for the project is expected to be 21,000 dollars immediately (at year 0); 5,000 dollars in 1 year; 37,000 dollars in 2 years; and 0 dollars in 3 years. Relevant expected operating cash flows and cash flows from capital spending in years 0, 1, 2, and 3 are presented in the following table. What is the net present value of this project?

Time 0 Year 1 Year 2 Year 3 Operating cash flows (in dollars) 0 59,000 67,000 50,000 Cash flows from capital spending (in dollars) -133,000 0 0 12,000

Explanation / Answer

Change in Net Working Capital:

Year 0 = $21,000 (This will be added in the initial outflow)
Year 1 = $5,000 - $21,000 = -$16,000 (This will be added in the cash inflow)
Year 2 = $37,000 - $5,000 = $32,000 (This will be deducted from the cash inflow)
Year 3 = $32,000 = $32,000 (This is the recovery of Net Working Capital at the end of the project and will be added back in the cash inflow)

Cash Flow:

Year 0 = -$133,000 - $21,000 = -$154,000 (Cash outflow)
Year 1 = $59,000 + $16,000 = $75,000 (Cash Inflow)
Year 2 = $67,000 - $32,000 = $35,000 (Cash Inflow)
Year 3 = $50,000 + $12,000 + $32,000 = $94,000 ( Cash Inflow)

($12,000 is the cash inflow from capital spending)

NPV = -$154,000 + {$75,000/(1+.1704)1} + {$35,000/(1+.1704)2} + {$94,000/(1+.1704)3} = -$5,738.16

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