Esfandiari Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.33 million. The fixed asset falls into the three-year MACRS class (MACRS schedule). The project is estimated to generate $1,735,000 in annual sales, with costs of $640,000. The project requires an initial investment in net working capital of $300,000, and the fixed asset will have a market value of $255,000 at the end of the project.

Required:
a. If the tax rate is 25 percent, what is the projectâs Year 0 net cash flow? Year 1? Year 2? Year 3?
b. If the required return is 9 percent, what is the project's NPV?

Project’s Year 0 net cash flow = - initial fixed asset investment - initial investment in net working capital = -$2,330,000 - $300,000 = -$2,630,000

Annual depreciation expenses = Positive value of Project’s Year 0 net cash flow / MACRS class number of years = $2,630,000 / 3 = $876,667

Project’s Year 1 net cash flow = (Annual sales – Annual costs - depreciation)(1 - tax) + depreciation = (1,735,000 - 640,000 - 876,667)*(1 - 0.25) + 876,667 = $1,040,416.75

Project’s Year 2 net cash flow = Project’s Year 1 net cash flow = $1,040,416.75

Non-operating year 3 cash flow = Market value at the end of the project + Net working capital - tax(Market value at the end of the project - Book value) = 255,000 +300,000 - 0.25 * (255,000 - 0) = $491,250

Project’s Year 3 net cash flow = Non-operating year 3 cash flow + Project’s Year 2 net cash flow = $491,250 + $1,040,416.75 = $1,531,666.75

b. If the required return is 9 percent, what is the project's NPV?

The NPV can be calculated using the following formula:

NPV = Project’s Year 0 net cash flow + (Project’s Year 1 net cash flow / (100% + Required return)^1) + (Project’s Year 2 net cash flow / (100% + Required return)^2) + (Project’s Year 3 net cash flow / (100% + Required return)^3) …………………. (1)

Using equation (1), we have:

NPV = -$2,630,000 + ($1,040,416.75 / (100% + 9%)^1) + ($1,040,416.75 / (100% + 9%)^2) + ($1,531,666.75 / (100% + 9%)^3) = $382,936.50

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