Question

Esfandairi Enterprises is considering a new three-year expansion project that requires an Initial fixed asset Investment of $2.31 million. The fixed asset falls into the three-year MACRS class (MACRS schedule). The project is estimated to generate $1,725,000 in annual sales, with costs of $632,000. The project requires an initial investment in net working capital of $280,000, and the fixed asset will have a market value of $225.000 at the end of the project.

a. If the tax rate is 23 percent, what is the project's Year 0 net cash flow? Year 1? Year 2?
Year 3? (A negative answer should be indicated by a minus sign. Do not round
intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to two decimal places, e.g., 1,234,567.89.)
b.If the required return is 11 percent, what is the project's NPV? (Do not round
intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to two decimal places, e.g., 1,234,567.89.)

Answer 1

The Year 0 net cash flow is the sum of the initial investments in fixed assets and net working capital. For Years 1 to 3, the net cash flow includes operating cash flow plus depreciation and, in Year 3, also includes the terminal cash flows. NPV is calculated by discounting these cash flows at the required return rate.

Step-by-step explanation:

To calculate the project's net cash flow for Esfandairi Enterprises, we begin in Year 0 with the initial investments. The initial fixed asset investment is $2,310,000 and the initial net working capital investment is $280,000, resulting in a total initial outflow of $2,590,000. This is the Year 0 net cash flow.

For Year 1, 2, and 3, we need to calculate the operating cash flows. The formula for operating cash flow (OCF) is OCF = (Sales - Costs)(1 - Tax Rate) + (Depreciation)(Tax Rate). The project generates annual sales of $1,725,000 and has annual costs of $632,000. Using the tax rate of 23%, the depreciation for each year will be derived from the three-year MACRS class. The final year will also include the terminal cash flows from the sale of the fixed asset and the recovery of net working capital.

To calculate the project's net present value (NPV), we discount each year's net cash flow at the required return of 11% and sum these values.

The project's Year 0 net cash flow is -$2,590,000. Years 1 to 3 cash flows are calculated using the formula for operating cash flow and including depreciation and terminal values, which are then used to calculate the NPV at a discount rate of 11%.