Quad Enterprises is considering a new three-year expansion project that requires
ID: 2776674 • Letter: Q
Question
Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.64 million. The fixed asset falls into the three-year MACRS class. The project is estimated to generate $2,060,000 in annual sales, with costs of $759,000. The project requires an initial investment in net working capital of $280,000, and the fixed asset will have a market value of $270,000 at the end of the project. If the tax rate is 35 percent, what is the project's Year 0 net cash flow? Year 1? Year 2? Year 3? If the required return is 13 percent, what is the project's NPV?Explanation / Answer
Calculation of depreciation:
year
1
2
3
Depreciation Basis
2640000
2640000
2640000
MACRS rate
33.33%
44.45%
14.81%
Depreciation
879912
1173480
390984
Depreciation
879912
1173480
390984
tax rate
35%
35%
35%
Depreciation tax shield
307969.2
410718
136844.4
Book value of asset at the end of 3rd year:
Book value = cost of asset – total depreciation
= 2,640,000 – (879912+1173480+390984)
= 195624
Net Salvage value = salvage value – capital gain tax
= 270,000 - (270,000-195624)x0.35
= 243968.4
Cash flows
Year
0
1
2
3
cost of fixed asset
-2640000
sales
2060000
2060000
2060000
cost of sales
-759000
-759000
-759000
EBIT
1301000
1301000
1301000
Tax 35%
-455350
-455350
-455350
Operating income
845650
845650
845650
Depreciation tax shield
307969.2
410718
136844.4
working capital
-280000
280000
Net salvage value
243968.4
Cash flows
-2920000.00
1153619.20
1256368.00
1506462.80
NPV
year
Cash flow
PV factor 13%
PV
0
-2920000.00
1.0000
-2920000.00
1
1153619.20
0.8850
1020901.95
2
1256368.00
0.7831
983920.43
3
1506462.80
0.6931
1044054.29
NPV
128876.67
Hence, NPV of the project is 128876.67.
year
1
2
3
Depreciation Basis
2640000
2640000
2640000
MACRS rate
33.33%
44.45%
14.81%
Depreciation
879912
1173480
390984