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 12%.
Calculate the NPV of the project:
A)$14,418.
B)$8,443.
C)$-2,735.
D)$12,873.

Question

Quizplus · Accepted Answer

To calculate the NPV of the project, we need to calculate the cash flows for each year.

Year 0:
Initial Investment = -$100,000 (90,000 for equipment and 10,000 for working capital)

Year 1:
Sales Revenue = $120,000
Manufacturing Costs = -$72,000 (60% of $120,000)
Depreciation = -$30,000 (90,000/3 years)
Net Operating Income = $18,000
Taxes (30%) = -$5,400
After-Tax Operating Income = $12,600
Net Operating Cash Flow = $42,600

Year 2:
Sales Revenue = $120,000
Manufacturing Costs = -$72,000
Depreciation = -$30,000
Net Operating Income = $18,000
Taxes (30%) = -$5,400
After-Tax Operating Income = $12,600
Net Operating Cash Flow = $42,600

Year 3:
Sales Revenue = $120,000
Manufacturing Costs = -$72,000
Depreciation = -$30,000
Net Operating Income = $18,000
Taxes (30%) = -$5,400
After-Tax Operating Income = $12,600
Salvage Value = $10,000
Tax on Salvage Value (30%) = -$3,000
Net Salvage Value = $7,000
Net Operating Cash Flow = $19,600

Now we can calculate the NPV using the cash flows and the cost of capital (12%):
NPV = -$100,000 + ($42,600/1.12^1) + ($42,600/1.12^2) + ($19,600/1.12^3) + ($7,000/1.12^3)
NPV = -$100,000 + $38,050.54 + $32,576.36 + $12,236.03 + $4,453.61
NPV = $14,418.53

Therefore, the best choice is A) $14,418. The project has a positive NPV, so it is expected to generate a return higher than the cost of capital.

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