Quad Enterprises is considering a new three-year expansion project that requires
ID: 2777722 • Letter: Q
Question
Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.73 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,090,000 in annual sales, with costs of $785,000. The tax rate is 30 percent and the required return on the project is 13 percent. What is the project’s NPV? (Enter your answer in dollars, not millions of dollars, e.g. 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.73 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,090,000 in annual sales, with costs of $785,000. The tax rate is 30 percent and the required return on the project is 13 percent. What is the project’s NPV? (Enter your answer in dollars, not millions of dollars, e.g. 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Explanation / Answer
Calculation of depreciation tax shield
year
1
2
3
Depreciation basis
2730000
2730000
2730000
Depreciation rate 1/3
33.33%
33.33%
33.33%
Depreciation
909909
909909
909909
x tax rate 30%
30%
30%
30%
Depreciation Tax shield
272972.7
272972.7
272972.7
Calculation of net salvage value
Book value =0
Net salvage value = salvage value – (salvage value – book value) x tax rate
= 225,000 – (225,000-206,739) x35%
= 218,608.65
Calculation of Cash flows
Year
0
1
2
3
initial cost of investment
-2730000
Sales revenue
2090000
2090000
2090000
(-) cost of sales
-785000
-785000
-785000
EBIT
1305000
1305000
1305000
(-) taxes 30%
-391500
-391500
-391500
Cash income
913500
913500
913500
Depreciation tax benefit
272972.7
272972.7
272972.7
net salvage value
0
Working capital
0
0
0
0
Net Cash flows
-2730000.00
1186472.70
1186472.70
1186472.70
Calculation of net present value
year
Cash flow
PV factor 13%
PV
0
-2730000.00
1.0000
-2730000.00
1
1186472.70
0.8850
1049975.84
2
1186472.70
0.7831
929182.16
3
1186472.70
0.6931
822285.10
NPV
71443.10
year
1
2
3
Depreciation basis
2730000
2730000
2730000
Depreciation rate 1/3
33.33%
33.33%
33.33%
Depreciation
909909
909909
909909
x tax rate 30%
30%
30%
30%
Depreciation Tax shield
272972.7
272972.7
272972.7