Louie's Leisure Products is considering a project which will require the purchase of $1.4 million in new equipment. The equipment belongs in a 20% CCA class. Louie's expects to sell the equipment at the end of the project for 20% of its original cost. Annual sales from this project are estimated at $1.2 million. Net working capital equal to 20% of sales will be required to support the project. All of the net working capital will be recouped at the end of the project. The firm desires a minimal 14% rate of return on this project. The tax rate is 34%.

What is the present value of the net working capital changes associated with the project?
The project is expected to last 7 years.

Question

What is the present value of the net working capital changes associated with the project?
The project is expected to last 7 years.

Quizplus · Accepted Answer

The present value of the net working capital changes is calculated by considering the initial investment in working capital and its recovery at the end of the project, discounted at the project's required rate of return. The initial working capital is 20% of $1.2 million, which is $240,000. This amount is recovered at the end of 7 years. The present value of this recovery is calculated using the formula for present value of a single sum: PV = FV / (1 + r)^n, where FV is the future value, r is the discount rate (14%), and n is the number of years (7). The present value of the recovery is $240,000 / (1.14)^7 = $95,913. The net present value of the working capital changes is -$240,000 + $95,913 = -$144,087.

Louie's Leisure Products Is Considering a Project Which Will Require