Question

Modern Flooring is considering a new product line. The new line would require $134,000 of fixed assets and net working capital of $24,000. The firm will apply straight-line depreciation to a zero salvage value over three years. The new line is expected to produce an operating cash flow of $35,000 the first year with that amount decreasing by 10 percent annually for two years before the new line will be discontinued. The fixed assets can be sold for $25,000 at the end of the project and all net working capital will be recovered. What is the net present value of the new line at a discount rate of 11.5 percent and a tax rate of 35 percent

Answer 1

-51,784

Step-by-step explanation:

Net present value can be calculated by first calculating the present values of operating cash flows each year and the sum up all the present values.

Year 0 1 2 3

Operating CF 35000 31500 28350

Fixed asset -134000

Net working capital -24000 24000

Disposal after tax 16250

(25000x0.65)

Net cashflow -158000 35000 31500 68600

PV Factor 1 0.896 0.804 0.721

PV -158000 31390 25337 49488

NPV = -158000 + 31390 + 25337 + 49488

NPV = -51,784

Workings

PV Factor

Year 0 = 1/(1.115)^0 = 1

Year 1 = 1/(1.115)^1 = 0.896

Year 2 = 1/(1.115)^2 = 0.804

Year 3 = 1/(1.115)^3 = 0.721