[rinoax16]

I need the answer to the last question...

Question 1
What is the net cost of the project for capital budgeting purposes? (That is, what is the Year 0 net cash flow?)

Initial Outlay $200K
Additional working capital required $50K
Total cash outlay $250K
Year 0 net cash flow (250K)

Question 2
What are the net operation cash flows for years 1, 2, and 3?

0 1 2 3 Earn $100,000 $100,000 $100,000
Dep. -$50,000 -$50,000 -$50,000

Taxable income $50,000 $50,000 $50,000
Tax at 40% -$20,000 -$20,000 -$20,000

After tax income $30,000 $30,000 $30,000
Add back dep. $50,000 $50,000 $50,000 W. cap.
Net Operating $80,000 $80,000 $80,000
Cash flow ______ ______ ______

Question 3
What is the terminal cash flow?

Proceeds from sale of
Pieces of the project $150,000
Add: working capital returned $50,000
Terminal cash flow $200,000

Question 4
If you use the WACC rate of 10% should you go ahead with the project?
Why?

[ArcSine]

Before you can proceed with the final evaluation of the project you've got a bit more to do with the terminal cash flow of Q 3.

The assets are being sold for 150K which will generate a taxable gain. The assets had an original cost of 200K, but 150K of depreciation (3 x 50) has been taken on them, reducing their carrying book value to 50K.

Compute the gain on sale, then the tax that'll be due on that gain. This tax will reduce your terminal-value cash flow.

Then to wrap it up, compute the project's yield (internal rate of return) on all the cash flows you've derived (all of which are correct, except for that omission of the terminal tax expense on the sale).

Finally, compare the project's IRR to the firm's WACC to determine if the project should be accepted or rejected.