Thomson Media is considering some new equipment whose data are shown below. The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down. Also, additional net operating working capital would be required, but it would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? Do not round the intermediate calculations and round the final answer to the nearest whole number.
WACC 10.0%
Net investment in fixed assets (depreciable basis) $70,000
Required net operating working capital $10,000
Straight-line depreciation rate 33.333%
Annual sales revenues $70,000
Annual operating costs (excl. depreciation) $30,000
Expected pre-tax salvage value $5,000
Tax rate 35.0%
To calculate the project's NPV (Net Present Value), we need to follow these steps:
Step 1: Calculate the depreciation expense each year.
The equipment has a 3-year tax life, so it will be fully depreciated over this period. Since the depreciation is done using the straight-line method, we can calculate the annual depreciation expense as follows:
Annual depreciation expense = (Initial investment – Salvage value) / Useful life
In this case, the initial investment is $70,000, and the salvage value is $5,000. The useful life is 3 years.
Annual depreciation expense = ($70,000 - $5,000) / 3 = $21,667
Step 2: Calculate the annual cash flows.
To calculate the annual cash flows, we need to consider revenues, operating costs, depreciation, taxes, and changes in net working capital.
Annual cash flows = (Revenues - Operating costs - Depreciation) * (1 - Tax rate) + Depreciation - Change in net working capital
In this case, revenues are $70,000, operating costs are $30,000, the tax rate is 35%, and the change in net working capital is $0 because it will be recovered at the end of the project's life.
Annual cash flows = ($70,000 - $30,000 - $21,667) * (1 - 0.35) + $21,667 - $0
Annual cash flows = $18,000
Step 3: Calculate the present value of each year's cash flows.
To calculate the present value of each year's cash flows, we need to discount them to their present value using the discount rate, which is the Weighted Average Cost of Capital (WACC). In this case, the WACC is 10%.
Year 1 Present Value = $18,000 / (1 + WACC)^1
Year 2 Present Value = $18,000 / (1 + WACC)^2
Year 3 Present Value = ($18,000 + Salvage Value) / (1 + WACC)^3
Step 4: Calculate the project's NPV.
The NPV is the sum of the present values of each year's cash flows minus the initial investment.
NPV = Year 1 Present Value + Year 2 Present Value + Year 3 Present Value - Initial investment
Now, let's calculate the NPV using the given values:
Year 1 Present Value = $18,000 / (1 + 0.10)^1 = $16,363
Year 2 Present Value = $18,000 / (1 + 0.10)^2 = $14,875
Year 3 Present Value = ($18,000 + $5,000) / (1 + 0.10)^3 = $18,423
NPV = $16,363 + $14,875 + $18,423 - $70,000 = -$20,339
Therefore, the project's NPV is approximately -$20,339 when rounding the final answer to the nearest whole number.