The firm is considering investing in a capital project
Subject: Business   / Finance
Question
Requirement: Excel spreadsheet showing calculations
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Question:
The firm is considering investing in a capital project; new production line equipment that will have an initial cost of $12 million. The equipment will have a productive life of 5 years, and at the end of this period, it is expected to have salvage value of $2 million (meaning the firm can sell the used equipment for $2 million). The equipment will be depreciated using the straight-line method for the full 5 years.
The new production equipment will supplement existing operations. The project is expected to increase revenue for the firm by $10 million per year and increase operating expenses by $6.5 million per year.
First, you need to calculate the annual depreciation on the new equipment; this depreciation figure is needed to calculate the cash flow generated by the project. Utilize the following table:
Initial Investment
Less Salvage Value
Total Depreciable Value
Life of Project (Years)
Depreciation per Year
Now, you need to calculate the relevant cash flows for the project. You can assume that the firm’s weighted average cost of capital (WACC) is 8%. The firm pays a 29% average tax rate. Utilize the following table:
Years
0
1
2
3
4
5
Revenue from Project
Operating Expenses
Depreciation (calculated above)
Taxable Income
Less Taxes (29% tax rate)
Net Income
Plus annual Depreciation
Operating Cash Flow
Plus Salvage Value (in year 5)
Relevant Cash Flows (Future Values)
PVIF table factor (i = 10%)
or you may use PV = FV / (1+ i) ^n
Present Value of cash flows (years 1-5)
Total of Present Value of Cash Flows
Initial Investment
Net Present Value of the Project
Calculate the present value of each relevant cash flow. You may use the PV equation or factors from the PVIF table. Then add them together and subtract the initial investment to calculate the net present value (NPV) of the project.
