Final answer:
The Year 0 net cash flow is $2.43 million. The net cash flows for Years 1, 2, and 3 are $593,333 each. The project's NPV, with a required return of 12%, is $837,637.19.
Step-by-step explanation:
a. The Year 0 net cash flow is equal to the initial fixed asset investment plus the initial net working capital investment, which is $2.18 million + $250,000 = $2.43 million.
For Year 1, the net cash flow is equal to the annual sales minus the costs, minus the depreciation expense, and plus the change in net working capital. Therefore, the net cash flow for Year 1 is $1.645 million - $610,000 - ($2.18 million / 3) + ($250,000 - $180,000) = $593,333.
For Year 2, the net cash flow is calculated in the same way as Year 1, with the only difference being the change in net working capital, which is equal to $0 since it remains constant. Therefore, the net cash flow for Year 2 is $1.645 million - $610,000 - ($2.18 million / 3) + ($0 - $0) = $593,333.
For Year 3, the net cash flow is equal to the annual sales minus the costs, minus the depreciation expense, and plus the change in net working capital. The change in net working capital is equal to the market value of the fixed asset at the end of the project minus the initial net working capital investment, which is $180,000 - $250,000 = -$70,000. Therefore, the net cash flow for Year 3 is $1.645 million - $610,000 - ($2.18 million / 3) + (-$70,000) = $573,333.
b. To calculate the project's NPV, we need to discount the net cash flows at the required return rate. The present value of each year's cash flow is:
- Year 0: $2.43 million / (1 + 12%)^0 = $2.43 million
- Year 1: $593,333 / (1 + 12%)^1 = $528,704.82
- Year 2: $593,333 / (1 + 12%)^2 = $471,494.20
- Year 3: $573,333 / (1 + 12%)^3 = $415,434.17
The NPV is calculated by subtracting the initial investment from the sum of the present values of all cash flows. Therefore, the project's NPV is $2.43 million + $528,704.82 + $471,494.20 + $415,434.17 - $2.18 million = $837,637.19.