Thomson Media is considering some new equipment whose data are shown below. The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down. Also, some new working capital would be required, but it would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV?
A) $20,762
B) $21,854
C) $23,005
D) $24,155
E) $25,363

Question

Thomson Media is considering some new equipment whose data are shown below. The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down. Also, some new working capital would be required, but it would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? 
A) $20,762 
B) $21,854 
C) $23,005 
D) $24,155 
E) $25,363

Quizplus · Accepted Answer

The NPV can be calculated as the present value of the cash inflows minus the present value of the cash outflows. In this case, the cash inflows are the after-tax operating cash flows and the salvage value at the end of Year 3, while the cash outflows are the initial investment in the new equipment and the additional working capital required. Using a discount rate of 10%, the NPV is calculated as:

Year 0:
- Initial investment: -$150,000
- Working capital: -$40,000
- Total cash outflow: -$190,000

Years 1-3:
- Operating cash inflows (after tax): $65,000 per year
- Total present value of operating cash inflows: $168,218

Year 3:
- Salvage value (before tax): $30,000
- Tax on salvage value: -$12,000
- After-tax salvage value: $18,000
- Present value of salvage value: $14,205

Total present value of cash inflows: $182,423

NPV = Total present value of cash inflows - Total cash outflow
NPV = $182,423 - $190,000
NPV = -$7,577

Since the NPV is negative, the project should not be undertaken.

Thomson Media Is Considering Some New Equipment Whose Data Are