CHAPTER 8
B-198
To calculate the OCF, we will use the tax shield approach, so the cash flow each year is:
OCF = (Sales
–
Costs)(1
–
t
C
) +
t
C
Depreciation
Year
Cash Flow
0
–
$4,400,000
=
–
$3,950,000
–
450,000
1
1,578,787
= $1,720,000(.65) + .35($1,316,535)
2
1,732,521
= $1,720,000(.65) + .35($1,755,775)
3
2,248,942
= $1,837,500(.65) + .35($584,995) + $450,000 + 476,193
Remember to include the NWC cost in Year 0, and the recovery of the NWC at the end of the project.
The NPV of the project with these assumptions is:
NPV =
–
$4,400,000 + ($1,578,787/1.10) + ($1,732,521/1.10
2
) + ($2,248,942/1.10
3
)
NPV = $156,759.92
6.
First, we will calculate the annual depreciation of the new equipment. It will be:
Annual depreciation charge = $625,000/5
Annual depreciation charge = $125,000
The aftertax salvage value of the equipment is:
Aftertax salvage value = $60,000(1
–
.35)
Aftertax salvage value = $39,000
Using the tax shield approach, the OCF is:
OCF = $235,000(1
–
.35) + .35($125,000)
OCF = $196,500
Now we can find the project IRR. There is an unusual feature that is a part of this project. Accepting
this project means that we will reduce NWC. This reduction in NWC is a cash inflow at Year 0. This
reduction in NWC implies that when the project ends, we will have to increase NWC. So, at the end
of the project, we will have a cash outflow to restore the NWC to its level before the project. We also
must include the aftertax salvage value at the end of the project. The IRR of the project is:
NPV = 0 =
–
$625,000 + 55,000 + 196,500(PVIFA
IRR%,5
) + [($39,000
–
55,000)/(1 + IRR)
5
]
IRR = 20.90%
7.
First, we will calculate the annual depreciation of the new equipment. It will be:
Annual depreciation = $267,000/5
Annual depreciation = $53,400
Now, we calculate the aftertax salvage value. The aftertax salvage value is the market price minus (or
plus) the taxes on the sale of the equipment, so:
Aftertax salvage value = MV + (BV
–
MV)
t
c