Question

The Smith & Warner Company is considering an expansion of its production facilities which will permit the firm to build and sell a new line of cell phones. The project requires a $10,000,000 capital investment and is expected to have a three-year economic life.

Other relevant information is :

At the end of the project, the equipment can be sold for $300,000.
The firm’s WACC is estimated at 8%.
Incremental sales are projected to be $12,000,000 per year.
Annual costs(excluding depreciation) are estimated to be $3,000,000
The project requires a $2,000,000 initial investment in net operating working capital.
The expected tax rate is 33%.

The MACRS depreciation schedule in the list below will be used:

Year 1 = 0.4445
Year 2 = 0.3333
Year 3 = 0.1481
Year 4 = 0.0741

Required:
Calculate and show the project cash flows for years 0 through 3.

Answer 1

The project cash flows for year 0 would be -$12,000,000

The project cash flows for year 1 would be $7,496,850

The project cash flows for year 2 would be$ 7,129,890

The project cash flows for year 3 would be $8,964,260

Step-by-step explanation:

According to the given data, the calculation of the project cash flows for years 0 through 3 would be as follows:

0 1 2 3

capital investment -10,000,000

initial investment in net -2,000,000

operating working capital.

Incremental sales 12,000,000 12,000,000 12,000,000

less: Annual costs -3,000,000 -3,000,000 -3,000,000

Depreciation - 4,445,000 -3,333,000 -1,481,000

Income before tax 4,555,000 5,667,000 7,519,000

less;tax -1,5031,50 -1,870,110 -2,481,270

Net income 3,051,850 3,796,890 5,037,730

Add:depreciation 4,445,000 3,333,000 1,481,000

After tax sale value 445,530

working capital released 2,000,000

cash flow -12,000,000 7,496,850 7,129,890 8,964,260

Depreciation 1=[10,000,000*0.4445]=- 4,445,000

Tax 1=[4,555,000*0.33]=-1,503,150

Book value at year 3 =10000000*7.41%=741000

Gain/(loss) on sale = 300000-741000=-441000

Tax saving due to loss = 441000*.33 = 145530

After tax sale value =sale value +tax saving

After tax sale value = 300000+145530 = 445530