Cochrane, Inc., is considering a new three-year expansion project that requires
ID: 2762140 • Letter: C
Question
Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,220,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,190,000 in annual sales, with costs of $1,180,000. The project requires an initial investment in net working capital of $154,000, and the fixed asset will have a market value of $179,000 at the end of the project. Assume that the tax rate is 30 percent and the required return on the project is 13 percent. Requirement 1: What are the net cash flows of the project for the following years? Requirement 2: What is the NPV of the project?Explanation / Answer
Initial Investment = $2,220,000
Net Working Capital = $154,000
Depreciation Per Year = $2,220,000/3 = $740,000
After tax market value of fixed asset at the end of project = $179,000 x (1-t) = $125,300
Requirement 1:
Year 0 = -$2,220,000 - $154,000 = -$2,374,000 (Outflow of $2,374,000)
Year
1
2
3
Sales
$2,190,000.00
$2,190,000.00
$2,190,000.00
Less: Cost
$1,180,000.00
$1,180,000.00
$1,180,000.00
Less: Depreciation
$740,000.00
$740,000.00
$740,000.00
EBT
$270,000.00
$270,000.00
$270,000.00
Less: Tax @ 30%
$81,000.00
$81,000.00
$81,000.00
Net Income
$189,000.00
$189,000.00
$189,000.00
Add: Net Working Capital
$0.00
$0.00
$154,000.00
Add: After tax salvage value of fixed asset
$0.00
$0.00
$125,300.00
Net Cash Flow
$189,000.00
$189,000.00
$468,300.00
Requirement 2:
NPV = -$2,374,000 + [($189,000)/(1.13)] + [($189,000)/(1.13)2] + [($468,300)/(1.13)3] = $1,224,916.15
Year
1
2
3
Sales
$2,190,000.00
$2,190,000.00
$2,190,000.00
Less: Cost
$1,180,000.00
$1,180,000.00
$1,180,000.00
Less: Depreciation
$740,000.00
$740,000.00
$740,000.00
EBT
$270,000.00
$270,000.00
$270,000.00
Less: Tax @ 30%
$81,000.00
$81,000.00
$81,000.00
Net Income
$189,000.00
$189,000.00
$189,000.00
Add: Net Working Capital
$0.00
$0.00
$154,000.00
Add: After tax salvage value of fixed asset
$0.00
$0.00
$125,300.00
Net Cash Flow
$189,000.00
$189,000.00
$468,300.00