Question

Lakeside Winery is considering expanding its winemaking operations. The expansion will require new equipment costing $693,000 that would be depreciated on a straight-line basis to zero over the 5-year life of the project. The equipment will have a market value of $190,000 at the end of the project. The project requires $60,000 initially for net working capital, which will be recovered at the end of the project. The operating cash flow will be $164,500 a year. What is the net present value of this project if the relevant discount rate is 10 percent and the tax rate is 21 percent?

a) $205,485.48

b) $206,521.89

c) $194,680.50

d) $192,925.11

Answer 1

The NPV calculation for the Lakeside Winery expansion project involves discounting all future cash flows at a rate of 10%, including the initial equipment cost, operating cash flows, the recovery of net working capital, and the salvage value of the equipment.

Step-by-step explanation:

The question asks for the calculation of the net present value (NPV) of a potential expansion project for Lakeside Winery. To calculate NPV, we consider all cash flows associated with the project, both inflows and outflows, accounting for the time value of money using a discount rate of 10%. The initial investment in equipment ($693,000), the recovery of net working capital at the end of the project ($60,000), the annual operating cash flows ($164,500), the tax rate (21%), and the salvage value of the equipment at the end of the project ($190,000) all play a role in determining the NPV.

Key steps include calculating the annual depreciation expense, adjusting operating cash flows for tax, and discounting all future cash flows (including the recovered net working capital and the salvage value of the equipment) back to their present value. These discounted cash flows are then summed to obtain the project's NPV.