[Busmommy]

Swannee Resorts is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, would be depreciated by the straight line method over the project's 3 year life, and would have zero (0) salvage value. No new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life.

W.A.C.C. 10%
Net investment cost (depreciable basis) $65,000
Straight line depr'n rate 33.33%
Sales revenues $70,000
Operating costs excl. depr'n $25,000
Tax rate 35%

What is the project's N.P.V?

[Clough]

Hi, Busmommy!

Are these homework questions that you've been asking on this site, please?

Thanks!

[Busmommy]

Yes. Which is why it is posted in the homework help section. Thank you.

[ArcSine]

Busmommy, Clough's question was a polite way of guiding you to read this forum's homework help rules... go back to the Homework's main page and check out the red-lettered message at the top.

[Busmommy]

Gotcha sorry about that.
My problem(s) so far with this problem would be:
1. Is the net investment cost (depreciable basis)= to depreciation costs?
2. Is sales revenue = to net sales?
With that I can find net income and determine my cash flows and then determine my N.P.V. Any assistance is appreciated, thank you.

[ArcSine]

Yes and yes. The way the problem's worded, the company will depreciate the asset as 65K/3 each year for 3 years. You'll need that amount to figure your tax expense for each year.

And, absent any other info (such as cost of sales, sales discounts, etc.) you can assume that Sales Revenue is the same as net sales.

[Busmommy]

Sales Revenues $70,000.00
Operating costs except depreciation 25,000.00
EBIT $45,000.00
Interest (Rate= 10%) 4,500.00
EBT $40,500.00
Taxes (Rate= 35%) 14,175.00
Net Income $26,325.00

Net Cash Flows= Net Income + Depreciation costs
Net Cash Flows= $91,325.00

NPV= Cash Flow/ (1+ r)^n= 91325/(1.10)^3
NPV= $68,613.82

Does this look correct? (Thanks)

[ArcSine]

It looks like you're trying to introduce an interest expense element that's not present in the original question, as worded above. And even if you wanted to include interest expense in the NPV analysis, keep in mind that such interest isn't a percentage of EBIT, but rather it's keyed to the outstanding debt balance.

For this problem, you need to determine the net cash flow for each of the three years, and discount each one to determine the project's PV. A comparison of this result with the cost of the investment will give the NPV. So the NPV calc will look like this:



The numerators are the net cash flow for each year, which you'll determine. For each year, the NCF will be Revenue, less Operating Costs, less Income Tax Expense.

Thus, before you can figure NCF for each year, you'll first need Tax Expense. That'll just be

0.35 x (Revenue minus Op Costs minus Depreciation (which is 1/3 of 65K each year)).

OK, there's the roadmap... I'll let you take the wheel of the bus and finish the trip. I'm sure you'll do fine.

[Busmommy]

Let's see if this is now correct. (Thanks.)
Tax expense:
.35* (70,000-25,000-21667)= 8,167
NCF:
70,000-25,000-8167= 36,833

NPV= 36833/(1.1)+ 36833/(1.1)^2+36833/(1.1)^3-65000
33485+30440+27673= 91598-65000= 26598 (would be my final answer?)

[ArcSine]

Yep, you got it. The project throws off after-tax cash flows of 36,833 a year for 3 years. At a discount rate of 10% these CFs have an aggregate PV of 91,598.

Since the project has a cost of 65K, acceptance of the project produces a positive NPV of 26,598 for our friends at Swannee--I'm sure they'll be pleased.

Well done. Got to sign off for a while, but it's certainly been a pleasure. Cheers!

[Busmommy]

Thank you, thank you, thank you! I cannot express my appreciation enough for all the help you have given me with these problems. And to top it all off, I even learned something new. :-) Thanks again!