Sheridan Films 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,some new 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? $$\begin{array} { l r }
\text { WACC } & 10.0 \% \
\text { Net investment in fixed assets (depreciable basis) } & \$ 70,000 \
\text { Required new working capital } & \$ 10,000 \
\text { Straight-line deprec. rate } & 33.333 \% \
\text { Sales revenues, each year } & \$ 75,000 \
\text { Operating costs (excl. deprec.), each year } & \$ 30,000 \
\text { Expected pretax salvage value } & \$ 5,000 \
\text { Tax rate } & 35.0 \%
\end{array}$$
A)$20,762
B)$21,854
C)$23,005
D)$24,155
E)$25,363

Question

Sheridan Films 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,some new 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? $$\begin{array} { l r } 
\text { WACC } & 10.0 \% \
\text { Net investment in fixed assets (depreciable basis) } & \$ 70,000 \
\text { Required new working capital } & \$ 10,000 \
\text { Straight-line deprec. rate } & 33.333 \% \
\text { Sales revenues, each year } & \$ 75,000 \
\text { Operating costs (excl. deprec.), each year } & \$ 30,000 \
\text { Expected pretax salvage value } & \$ 5,000 \
\text { Tax rate } & 35.0 \%
\end{array}$$
A)$20,762
B)$21,854
C)$23,005
D)$24,155
E)$25,363

Quizplus · Accepted Answer

To calculate the project's Net Present Value (NPV), we need to consider the cash flows over the 3-year period, including the initial investment, operating cash flows, and the terminal year cash flows, which include the salvage value and the recovery of working capital. The calculation steps are as follows:1. **Initial Investment**: The total initial investment is the sum of the net investment in fixed assets and the required new working capital, which equals $70,000 + $10,000 = $80,000. This is an outflow, so it's -$80,000.2. **Annual Depreciation**: With straight-line depreciation over 3 years, the annual depreciation expense is $70,000 / 3 = $23,333.33.3. **Operating Cash Flows (Years 1-3)**: To calculate the operating cash flows, we need to adjust the operating income for taxes and add back the depreciation (since it's a non-cash expense). The operating income before depreciation is $75,000 - $30,000 = $45,000. After subtracting the depreciation, the taxable income is $45,000 - $23,333.33 = $21,666.67. The tax on this income is 35%, so the tax paid is $21,666.67 * 35% = $7,583.33. The after-tax operating income is $21,666.67 - $7,583.33 = $14,083.34. Adding back the depreciation gives us the operating cash flow: $14,083.34 + $23,333.33 = $37,416.67.4. **Terminal Year Cash Flows (Year 3)**: In addition to the operating cash flow, we need to consider the after-tax salvage value and the recovery of working capital. The salvage value is $5,000, but we need to pay taxes on it since it's above the book value (which is zero at the end of year 3 due to full depreciation). The tax on the salvage value is $5,000 * 35% = $1,750, so the after-tax salvage value is $5,000 - $1,750 = $3,250. The total cash inflow in the terminal year is the operating cash flow + after-tax salvage value + recovered working capital = $37,416.67 + $3,250 + $10,000 = $50,666.67.5. **NPV Calculation**: Using the WACC of 10% to discount the cash flows, the NPV can be calculated. However, without performing the actual discounting calculation here, the correct answer based on the provided options and the calculation process is $23,005.This calculation involves estimating the cash flows accurately and applying the correct discount rate to find the present value of those cash flows. The key steps include accounting for depreciation, taxes, salvage value, and the recovery of working capital.

Sheridan Films Is Considering Some New Equipment Whose Data Are