Wednesday, 9 July 2014

Keiper, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.49 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,010,000 in annual sales, with costs of $705,000. The tax rate is 34 percent and the required return on the project is 16 percent. What is the project’s NPV?

Keiper, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.49 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,010,000 in annual sales, with costs of $705,000. The tax rate is 34 percent and the required return on the project is 16 percent. What is the project’s NPV? (Round your answer to 2 decimal places. (e.g., 32.16))

  NPV $  


Explanation:
Using the tax shield approach to calculating OCF (Remember the approach is irrelevant; the final answer will be the same no matter which of the four methods you use.), we get:

OCF = (Sales − Costs)(1 − T) + T(Depreciation)
OCF = ($2,010,000 − 705,000)(1 − 0.34) + 0.34($2,490,000/3)
OCF = $1,143,500

Since we have the OCF, we can find the NPV as the initial cash outlay plus the PV of the OCFs, which are an annuity, so the NPV is:

NPV = −$2,490,000 + $1,143,500(PVIFA16%,3)
NPV = $78,174.69