Question

Down under boomerang, inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.64 million. the fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. the project is estimated to generate $2,060,000 in annual sales, with costs of $755,000. the tax rate is 35 percent and the required return on the project is 13 percent. what is the project’s npv?

Answer 1

To answer this problem, 1st let us calculate the total annual cash flow.

We define the given variables:

Annual Income = $2,060,000

Annual Cost = $755,000

Annual Profit = $2,060,000 - $755,000 = $1,305,000

Annual Tax = $1,305,000 * 0.35 = $456,750

Depreciation = $2.64 million / 3 = $880,000

Savings from Depreciation = $880,000 * 0.35 = $308,000

Therefore,

Annual Cash Flow = Annual Profit + Savings from Depreciation

Annual Cash Flow = $1,305,000 + $308,000

Annual Cash Flow = $1,613,000

The present value of annuity is:

P = A [1 – (1 + i)^-n ] / i

P = $1,613,000 [1 – (1 + 0.13)^(-3)] / 0.13

P = $3,808,539.14 = NPV