Problem:
Company A is considering a major expansion of its business. The details of the proposed expansion project are summarized below:
- The company will have to purchase $500,000 in equipment at t = 0. This is the depreciable cost.
- The project has an economic life of four years.
- The cost can be depreciated on a MACRS 3-year basis, which implies the following depreciation schedule:
MACRS
Depreciation
Year Rates
1 0.33
2 0.45
3 0.15
4 0.07
- At t = 0, the project requires that inventories increase by $50,000 and accounts payable increase by $10,000. The change in net operating working capital is expected to be fully recovered at t = 4.
- The project's salvage value at the end of four years is expected to be $0.
- The company forecasts that the project will generate $800,000 in sales the first two years (t = 1 and 2) and $500,000 in sales during the last two years (t = 3 and 4).
- Each year the project's operating costs excluding depreciation are expected to be 60% of sales revenue.
- The company's tax rate is 40%.
- The project's cost of capital is 10%.
What is the net present value (NPV) of the proposed project?