Maple Media is considering a proposal to enter a new line of business. In review
ID: 2769898 • Letter: M
Question
Maple Media is considering a proposal to enter a new line of business. In reviewing the proposal, the company's CFO is considering the following facts: The new business will require the company to purchase additional fixed assets that will cost $600,000 at t = 0. For tax and accounting purposes, these costs will be depreciated on a straight-line basis over three years. (Annual depreciation will be $200,000 per year at t = 1, 2, and 3.) At the end of three years, the company will get out of the business and will sell the fixed assets at a salvage value of $100,000. The project will require a $50,000 increase in net operating working capital at t = 0, which will be recovered at t = 3. The company's marginal tax rate is 35 percent. The new business is expected to generate $2 million in sales each year (at t = 1, 2, and 3). The operating costs excluding depreciation are expected to be $1.4 million per year. The project's cost of capital is 12 percent. What is the project's net present value (NPV)? The answer is $536,697, but an explanation would be helpful.
Explanation / Answer
Terminal cashflows from selling the machine = 10000 - Capital Gaisn Tax
As the book value of the assetw will be zero hence capital gain woudl be paid on entire 100,000*35% =35000
Hence after tax cashflows from the equipment would be = 100000 -35000 =$65000
1 2 3 Sales 2000000 2000000 2000000 Operating Cost 1400000 1400000 1400000 Depreciation 200000 200000 200000 PBT 400000 400000 400000 Tax 140000 140000 140000 PAT 260000 260000 260000 PAT +Dep 460000 460000 460000 Intial Investment -6,00,000 Salavge value 65000 Increase in WC -50,000 release of WC 50000 Total Cashflows -6,50,000 460000 460000 575000 4,79,193.85