Question

Assume that you are looking at an investment opportunity that offers an annual operating cash flow of $40,000 per year for 4 years. The initial investment to purchase the necessary equipment is $200,000. You assume that you can sell the equipment at the end of 4 years for $70,000. Also, there is a need for an investment in net working capital of $15,000. If the required rate of return is 5%, and the tax rate is 35%, would you accept this project?

Answer 1

No, I would not accept the project.

Step-by-step explanation:

The initial investment will be equipment cost of $200,000 plus working $15,000 totaling to $215,000.

The cash flow after tax will be $26,000 {$40,000 x (1 - 35% tax rate)}

The salvage value of the equipment is $70,000 plus working capital of $15,000 totaling to a value of $85,000.

Following formula will be used to calculate present value of annuity payment of $26,000 for four years and present value of $85,000:

`PV=PMT(1+(1/(1+r)^n)/r+FV/(1+r)^n`

PV = Present Value

PMT = Annuity Payment

r = Interest Rate

FV = Future Value

n = Number of periods

Calculation

Data:

r = 5%

n = 4

PMT = $26,000

FV = $85,000

`26000(1+(1/(1+0.05)^4)/0.05+85000/(1+0.05)^4=162124.42`

The net present value of the project is $215,000 - $162,124.42 = $-52,875.58

The project is not economically valuable.