Finance

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Wheel Industries is considering a three year expansion project.

The project requires an initial investment of $1.5 million. The project will use straight line depreciation method. The project has no salvage value. It is estimated that the project will generate additional revenues of $1.2 million and has costs of $600,000.

The tax rate is 35%. Calculate the cash flows for the project. If the discount rate is 6% calculate the NPV of the project.

  • Finance -

    . Depreciation = Cost of the asset – salvage value
    Life of the asset
    = 1,500,000/ 3
    = 500,000
    Calculation of cash flows:
    Revenue – 1,200,000
    Less Cost – 600,000
    Less Depreciation – 500,000
    Profit - 100,000
    Less taxes (35%) 35,000
    Profit after taxes 65,000
    Add depreciation 500,000
    Cash flow after taxes 565,000

    NPV = Present value of cash flows - Cash outlay
    = 565,000 x PVIFA 6%, 3 years – 1,200,000
    = 565,000 x 2.6730 – 1,200,000
    = 1,510,245 – 1,200,000
    = 310,245

    This project should be accepted because the NPV is positive.

  • Finance -

    SORRY I MISCALCULATED SOMETHING!!! HERE IS THE CORRECT SOLUTION!


    a. Cash flows (Millions of Dollars)
    Year 0 Year 1 Year 2 Year 3
    Initial Investment –1.5
    Sales 1.2 1.2 1.2
    Costs 0.6 0.6 0.6
    –Depreciation 0.5 0.5 0.5
    EBT 0.1 0.1 0.1
    Taxes 0.035 0.035 0.035
    NI 0.065 0.065 0.065
    + Depreciation 0.5 0.5 0.5
    OCF 0.565 0.565 0.565

    Total cash flows –1.5 0.565 0.565 0.565

    NPV at 6% = –1,500,000 + 565,000/(1.06) + 565,000/(1.06)2 + 565,000/(1.06)3
    = –1,500,000 + 533,018.869 + 502,847.988 + 474,384.894
    = $10,251.751
    NPV = +$10,251 Acceptable project
    The PV could have been calculated by using the table in the back of the text.
    b. r = D1/ P0 + g = [2.50(1.06)/50] + 0.06 = 11.3%

  • Finance -

    fOR THE npv CALCULATION,
    -1,5000,000 + 565,000/(1.06)+ 565,000/(1.06)^2 + (1.06)^3
    tHEY ARE SUPPOSED TO BE EXPONENTS. aLSO KEEP IN MIND THAT THE SET OF 3 NUMBERS YOU SEE IN PART a UNDER CASH FLOWS, REPRESENT THE AMOUNT IN YEAR 1, YEAR 2, AND YEAR 3, WHERE THERE IS A FOURTH NUMBER IN THE ROW THAT IS FOR YEAR 0. i'M SORRY FOR THE PRIOR CONFUSION AND THAT THIS PASTED WEIRD---I HOPE THIS HELPS.

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