A project requires an initial investment in equipment of $90,000 and then requires an initial investment in working capital of $10,000 (at t = 0). You expect the project to produce sales revenue of $120,000 per year for three years. You estimate manufacturing costs at 60 percent of revenues. (Assume all revenues and costs occur at year-end [i.e., t = 1, t = 2, and t = 3]). The equipment depreciates using straight-line depreciation over three years. At the end of the project, the firm can sell the equipment for $10,000. The corporate tax rate is 21 percent and the cost of capital is 16.5 percent. Calculate the NPV of the project.
A)$9,826
B)$3,840
C)-$2,735
D)$4,848

Question

Quizplus · Accepted Answer

The correct answer is A because the NPV of the project is $9,826. The NPV is calculated as follows:```NPV = -Initial Investment + Sum of Present Value of Cash Flows``````Initial Investment = $90,000 + $10,000 = $100,000``````Present Value of Cash Flows = (Sales Revenue - Manufacturing Costs - Depreciation) * (1 - Tax Rate) * Present Value Factor``````Year 1:Sales Revenue = $120,000Manufacturing Costs = $72,000Depreciation = $30,000Tax Rate = 21%Present Value Factor = 0.8573Present Value of Cash Flows = ($120,000 - $72,000 - $30,000) * (1 - 0.21) * 0.8573 = $19,034``````Year 2:Sales Revenue = $120,000Manufacturing Costs = $72,000Depreciation = $30,000Tax Rate = 21%Present Value Factor = 0.7285Present Value of Cash Flows = ($120,000 - $72,000 - $30,000) * (1 - 0.21) * 0.7285 = $16,030``````Year 3:Sales Revenue = $120,000Manufacturing Costs = $72,000Depreciation = $30,000Tax Rate = 21%Present Value Factor = 0.6139Present Value of Cash Flows = ($120,000 - $72,000 - $30,000) * (1 - 0.21) * 0.6139 = $13,162``````Salvage Value = $10,000Present Value of Salvage Value = $10,000 * 0.6139 = $6,139``````NPV = -$100,000 + $19,034 + $16,030 + $13,162 + $6,139 = $9,826```

A Project Requires an Initial Investment in Equipment of $90,000