Quad Enterprises is considering a new three-year expansion project that requires
ID: 2777765 • Letter: Q
Question
Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.79 million. The fixed asset falls into the three-year MACRS class. The project is estimated to generate $2,110,000 in annual sales, with costs of $799,000. The project requires an initial investment in net working capital of $330,000, and the fixed asset will have a market value of $225,000 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? (MACRS schedule) (Enter your answers in dollars, not millions of dollars, e.g. 1,234,567. Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places, e.g., 32.16.)
Explanation / Answer
Calculation of depreciation tax shield
year
1
2
3
Depreciation basis
2790000
2790000
2790000
Depreciation rate 1/3
33.33%
44.45%
14.81%
Depreciation
929907
1240155
413199
x tax rate 35%
35%
35%
35%
Depreciation Tax shield
325467.45
434054.25
144619.65
Calculation of net salvage value
Book value = cost of asset x last year macrs rate
= 2,790,000 x7.41%
= 206,739
Net salvage value = salvage value – (salvage value – book value) x tax rate
= 225,000 – (225,000-206,739) x35%
= 218,608.65
Cash flows:
Year
0
1
2
3
initial cost of investment
-2790000
Sales revenue
2110000
2110000
2110000
(-) cost of sales
-799000
-799000
-799000
EBIT
1311000
1311000
1311000
(-) taxes 35%
-458850
-458850
-458850
Cash income
852150
852150
852150
Depreciation tax benefit
325467.45
434054.25
144619.65
net salvage value
218608.65
Working capital
-330000
0
0
330000
Net Cash flows
-3120000.00
1177617.45
1286204.25
1545378.30
year
1
2
3
Depreciation basis
2790000
2790000
2790000
Depreciation rate 1/3
33.33%
44.45%
14.81%
Depreciation
929907
1240155
413199
x tax rate 35%
35%
35%
35%
Depreciation Tax shield
325467.45
434054.25
144619.65