A project requires an initial investment in equipment of $90,000 and then requires an initial investment in working capital of $10,000 (at t = 0).You expect the project to produce sales revenue of $120,000 per year for three years.You estimate manufacturing costs at 60% of revenues.(Assume all revenues and costs occur at year-end,i.e.,t = 1,t = 2,and t = 3.)The equipment depreciates using straight-line depreciation over three years.At the end of the project,the firm can sell the equipment for $10,000 and also recover the investment in net working capital.The corporate tax rate is 30% and the cost of capital is 15%.Calculate the NPV of the project:
A)$3,840.
B)$8,443.
C)$-2,735.
D)$7,342.

Question

Quizplus · Accepted Answer

Year 0:
Initial investment in equipment = -$90,000
Initial investment in net working capital = -$10,000
Total cash outflow = -$100,000

Year 1:
Sales revenue = $120,000
Manufacturing costs = $72,000 (60% of revenues)
Depreciation expense = $30,000 ($90,000/3 years)
Taxable income = $18,000
Taxes = $5,400 (30% of taxable income)
Net cash flow = $42,600 ($120,000 - $72,000 - $30,000 - $5,400)

Year 2:
Sales revenue = $120,000
Manufacturing costs = $72,000 (60% of revenues)
Depreciation expense = $30,000 ($90,000/3 years)
Taxable income = $18,000
Taxes = $5,400 (30% of taxable income)
Net cash flow = $42,600 ($120,000 - $72,000 - $30,000 - $5,400)

Year 3:
Sales revenue = $120,000
Manufacturing costs = $72,000 (60% of revenues)
Depreciation expense = $30,000 ($90,000/3 years)
Taxable income = $18,000
Taxes = $5,400 (30% of taxable income)
Net cash flow = $42,600 ($120,000 - $72,000 - $30,000 - $5,400)

End of Year 3:
Equipment sale proceeds = $10,000
Net working capital recovery = $10,000
Taxable gain on sale of equipment = $10,000 - $7,500 (book value) = $2,500
Taxes on gain = $750 (30% of taxable gain)
Net cash flow from equipment sale = $9,250 ($10,000 - $750)

Calculate the NPV using the cost of capital of 15%:
NPV = -$100,000 + ($42,600/(1+0.15)^1) + ($42,600/(1+0.15)^2) + ($42,600/(1+0.15)^3) + ($9,250/(1+0.15)^3)
NPV = $8,443

Therefore, the best choice is B.

A Project Requires an Initial Investment in Equipment of $90,000