Question

Esfandairi Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.18 million. The fixed asset will be depreciated straightline to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $1.645 million in annual sales, with costs of $610,000. The project requires an initial investment in net working capital of $250,000, and the fixed asset will have a market value of $180,000 at the end of the project. The tax rate is 21 percent. a. 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, e.g., 1,234,567.) b. If the required return is 12 percent, what is the project's NPV? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

The net cash flow for the project is calculated as $2.43 million in Year 0, $1.035 million in Year 1 and Year 2, and $1.215 million in Year 3. The project's NPV, based on a required return rate of 12%, is $752,699.26.

Step-by-step explanation:

The net cash flow for the project can be calculated as follows:

Year 0:
Initial fixed asset investment + Initial investment in net working capital = $2.18 million + $250,000 = $2.43 million

Year 1:
Sales - Costs = $1.645 million - $610,000 = $1.035 million

Year 2:
Sales - Costs = $1.645 million - $610,000 = $1.035 million

Year 3:
Sales - Costs + End of project market value of fixed asset = $1.645 million - $610,000 + $180,000 = $1.215 million

The net present value (NPV) of the project can be calculated by discounting the cash flows at the required return rate of 12%. The NPV formula is:

NPV = Year 0 net cash flow + (Year 1 net cash flow / (1 + Required return rate)^1) + (Year 2 net cash flow / (1 + Required return rate)^2) + (Year 3 net cash flow / (1 + Required return rate)^3)

Using the given cash flows and the required return rate, the NPV of the project is calculated to be $752,699.26.

Answer 2

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.