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Down Under Boomerang, Inc., is considering a new 3-year expansion project that requires an initial fixed...

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Finance

Down Under Boomerang, Inc., is considering a new 3-yearexpansion project that requires an initial fixed asset investmentof $2.18 million. The fixed asset will be depreciated straight-lineto zero over its 3-year tax life. The project is estimated togenerate $1,730,000 in annual sales, with costs of $640,000. Theproject requires an initial investment in net working capital of$290,000, and the fixed asset will have a market value of $240,000at the end of the project.

a.

If the tax rate is 24 percent, what is the project’s Year 0 netcash flow? Year 1? Year 2? Year 3?

b.

If the required return is 12 percent, what is the project'sNPV?

Answer & Explanation Solved by verified expert
3.7 Ratings (663 Votes)

Initial investment (year 0)
fixed assets investment -2180000
working capital -290000
Year 0 cash flow is -2470000
Year 1 Year2 Year 3
Sales 1730000.00 1730000.00 1730000.00
Less : costs -640000.00 -640000.00 -640000.00
less : depreciation (2180000/3)= -726666.67 -726666.67 -726666.67
Profit before tax 363333.33 363333.33 363333.33
less : tax @24% -87200.00 -87200.00 -87200.00
Profit after tax 276133.33 276133.33 276133.33
Add : Depreciation 726666.67 726666.67 726666.67
Add :market value at end - - 240000.00

Less : tax on capital gain 24%

 -57600.00

Add : Working capital received at end

 290000.00
Free cash flow 1002800.00 1002800.00 1475200.00

Calcultion of NPV
i = 12%
Year 0 1 2 3
free Cash flow -2470000 1002800.00 1002800.00 1475200.00
PVF = 1/(1+i)^n= 1 0.8928571429 0.7971938776 0.7117802478

for year 1 PVF =1/(1+20%)^1
and so on
PV= FCf * PVF -2470000 895357.1429 799426.0204 1050018.222
NPV (total of pv) 274801.3848

NPV is $274801.38. So project should be accepted.

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