Question

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.52 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,020,000 in annual sales, with costs of $715,000. The tax rate is 30 percent and the required return is 16 percent. The project requires an initial investment in net working capital of $240,000, and the fixed asset will have a market value of $290,000 at the end of the project.

Answer 1

The Net Present Value (NPV) of Down Under Boomerang, Inc.'s expansion project is $199,470.88, indicating that the project is financially viable.

Step-by-step explanation:

Down Under Boomerang, Inc. is evaluating a three-year expansion project with an initial fixed asset investment of $2.52 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The annual sales are estimated at $2,020,000, with costs of $715,000. To calculate NPV, we need to find the cash flows over the project's life. Cash inflows are the sales revenue minus costs, yielding $1,305,000 annually.

The depreciation tax shield is calculated by multiplying the depreciation expense by the tax rate (30%). The initial investment in net working capital is $240,000. The terminal cash flow is the salvage value of the fixed asset minus the tax on the salvage value. Applying the NPV formula with a required return of 16%, we find that NPV = -$2,520,000 + $1,305,000/(1+0.16) + $1,305,000/
`(1+0.16)^2` + ($290,000 - $290,000*0.3)/
`(1+0.16)^3` + $240,000/
`(1+0.16)^3`, resulting in NPV = $199,470.88.

The positive NPV indicates that the project is expected to generate a return higher than the required 16% rate of return. This suggests that Down Under Boomerang, Inc. should proceed with the expansion project, as it adds value to the firm. It's crucial for businesses to assess NPV when making investment decisions, ensuring that the project aligns with the company's financial objectives and generates positive returns for shareholders.