Bourque Enterprises is considering a new project. The project will generate sales of $1.6 million, $2.3 million, $2.2 million, and $1.7 million over the next four years, respectively. The fixed assets required for the project will cost $2.1 million and will be eligible for 100 percent bonus depreciation. At the end of the project, the fixed assets can be sold for $165,000. Variable costs will be 25 percent of sales and fixed costs will be $540,000 per year. The project will require NWC equal to 20 percent of sales that must be accumulated in the year prior to sales. The required return on the project is 13 and the tax rate is 24 percent.What is the NPV of the project?

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Asked Mar 29, 2019
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Bourque Enterprises is considering a new project. The project will generate sales of $1.6 million, $2.3 million, $2.2 million, and $1.7 million over the next four years, respectively. The fixed assets required for the project will cost $2.1 million and will be eligible for 100 percent bonus depreciation. At the end of the project, the fixed assets can be sold for $165,000. Variable costs will be 25 percent of sales and fixed costs will be $540,000 per year. The project will require NWC equal to 20 percent of sales that must be accumulated in the year prior to sales. The required return on the project is 13 and the tax rate is 24 percent.

What is the NPV of the project?

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Expert Answer

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Step 1

As a first step, let's calculate the NOPAT and working capital requirement of the project. Please see the table below. Please see the column titled "Linkage". This will help you understand the mathematics.

Each term is preceeded by [+] / [-} sign that will tell you whether a particular item is added to or substracted from.

All the financial in this solution are in $ mn.

Year, NLinkage01234
SalesS     1.6000    2.3000           2.2000           1.7000
[-] Variable costs=25% x S     0.4000    0.5750           0.5500           0.4250
[-] Fixed costs      0.5400    0.5400           0.5400           0.5400
[-] DepreciationRefer Note 1     2.1000             -                      -                      -  
Operating income    (1.4400)    1.1850           1.1100           0.7350
[-] Taxes=24%*Operating income   (0.3456)    0.2844           0.2664           0.1764
NOPAT    (1.0944)    0.9006           0.8436           0.5586
       
Working capital=20% x S        0.3200    0.4600    0.4400           0.3400                    -  
Step 2

Note (1): The asset is allowed for 100% bonus depreciation. Hence the depreciation charged to the books in the first year itself = 100% of the capital cost = 100% x 2.1 = 2.1

Note (2): Investment in working capital = Working capital of year n - working capital of year n-1 = Difference of working capital of successive years

Note (3): Salvage Value = 0.165

Tax basis = 0

Hence, gain on sale= Salvage value - tax basis = 0.165

Hence, tax = Gain on sale x Tax rate = 0.165 x 24% = 0.0396

hence, post tax salvage value = Pre tax salvage value - tax on gain on sale= 0.165 - 0.0396 = 0.1254

Step 3

Please see th etable below for NPV calculation:

Cash flow calculation      
Year, NLinkage01234
NOPATLinkage                 -    (1.0944)    0.9006           0.8436           0.5586
[+] Depreciation      2.1000             -                      -                      -  
[-] Investment in working capitalRefer Note 2        0.3200    0.1400  (0.0200)         (0.1000)          (0.3400)
[-] Capital expenditure         2.1000             -               -                      -                      -  
[+] Post tax salvage valueRefer Note 3            ...

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