In analyzing a new potential business MacDonald Publishing’s financial staff is estimating an initial capital expenditure of $6.1 million. This equipment will be depreciated according to the MACRS 3 year class life and will have a market value of $1 million after four years. If MacDonald goes ahead with the new business, inventories and accounts payable will increase by $300,000 each. The new business is expected to have an economic life of four years and is expected to generate annual sales of 5 million and incur operating costs (excluding depreciation) of 3 million annually. If the company’s tax rate is 40 percent and the required return is 10 percent, calculate the expected NPV of the new business
Answer:NPV of the project is $ 144303.4
Working notes for the above answer is as under
We have been providede with the information that,
| capital expenditure of | 6,100,000 |
| This equipment will be depreciated by | MACRS 3 |
| Salvage at 4 th year | 1,000,000 |
| accounts payablenventory will increase | 300,000 |
| Increase in Sales | 5,000,000 |
| Increase in operating Expense | 3,000,000 |
| Increase in profit | 2,000,000 |
| Tax Rate | 40% |
Now with the help of this figure we will calculate NPV of the project as follow
Calculation of depriciation is as follow as per MACRs 3 year
| year | Initial Amount | Dep. Rate | Depriciation | Closing Balance |
DTS=Dep*.40 |
| 1 | 6,100,000 | 33.33% | 2033130 | 4,066,870 | 813252 |
| 2 | 6,100,000 | 44.45% | 2711450 | 1,355,420 | 1084580 |
| 3 | 6,100,000 | 14.81% | 903410 | 452,010 | 361364 |
| 4 | 6,100,000 | 7.41% | 452010 | 0 | 180804 |
Calculation Of NPv
| year | Cash Flow | Salvage | Total cash Inflow |
Less : Tax | After Tax Cash Inlow |
Add: DTs | Net Cash Inflow |
Pv Factor @10% |
Prasent Vaue |
| 0 | -6,100,000 | -6,100,000 | 1 | -6100000 | |||||
| 1 | 2,000,000 | 2,000,000 | 800000 | 1,200,000 | 813252 | 2,013,252 | 0.909091 | 1830229 | |
| 2 | 2,000,000 | 2,000,000 | 800000 | 1,200,000 | 1084580 | 2,284,580 | 0.826446 | 1888083 | |
| 3 | 2,000,000 | 2,000,000 | 800000 | 1,200,000 | 361364 | 1,561,364 | 0.751315 | 1173076 | |
| 4 | 2,000,000 | 1000000 | 3,000,000 | 1200000 | 1,800,000 | 180804 | 1,980,804 | 0.683013 | 1352916 |
| 144303.4 |
