Cochrane, Inc., is considering a new three-year expansion project that requires
ID: 2763826 • 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 S179,000 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
Time line 0 1 2 3 Cost of new machine -2220000 Increase in working capital -154000 =Initial Investment outlay -2374000 Profit= Sales - operating cost 1010000 1010000 1010000 -Depreciation Cost of new machine/3 -740000 -740000 -740000 0 =Salvage book value =Pretax cash flows 270000 270000 270000 -taxes =(Pretax cash flows)*(1-tax) 189000 189000 189000 +Depreciation 740000 740000 740000 =after tax operating cash flow 929000 929000 929000 Reversal of NWC 154000 +selling price*(1-tax rate) 125300 +Salvage BV*tax rate 0 =after tax non operating CF 279300 Total Cash flow for the period -2374000 929000 929000 1208300 IRR= 13.00% Discount factor= (1+ required rate)^N 1 1.13 1.2769 1.442897 Discounted cash flow= total cash flow/discount factor -2374000 822123.9 727543.3 837412.5 NPV= Sum of discounted cash flow = 13079.67