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GnuYak Industries is considering a new project that will last for three years. This project requires...

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Finance

GnuYak Industries is considering a new project that will lastfor three years. This project requires an initial investment in amachine that costs £90,000 immediately (year 0) and will bedepreciated in straight line over its three-year life to a residualvalue of 0. The management expects this project will result insales of £100,000 and cost of goods sold will be 50% of sales eachyear. This project also requires a total net working capital of£10,000 in year 0 which will be fully recovered in year 3. GnuYakis in the 35% corporate tax bracket.

a. Calculate the total Free Cash Flows for each year of this newproject.

b. Suppose that the appropriate discount rate for this projectis 10%, calculate the NPV of this project.

Answer & Explanation Solved by verified expert
4.4 Ratings (812 Votes)

Time line 0 1 2 3
Cost of new machine -90000
Initial working capital -10000
=Initial Investment outlay -100000
Sales 100000 100000 100000
Profits Sales-variable cost 50000 50000 50000
-Depreciation Cost of equipment/no. of years -30000 -30000 -30000
=Pretax cash flows 20000 20000 20000
-taxes =(Pretax cash flows)*(1-tax) 13000 13000 13000
+Depreciation 30000 30000 30000
=a. FCF 43000 43000 43000
reversal of working capital 10000
+Tax shield on salvage book value =Salvage value * tax rate 0
=Terminal year after tax cash flows 10000
Total Cash flow for the period -100000 43000 43000 53000
Discount factor= (1+discount rate)^corresponding period 1 1.1 1.21 1.331
Discounted CF= Cashflow/discount factor -100000 39090.90909 35537.19 39819.684
b. NPV= Sum of discounted CF= 14447.78

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Transcribed Image Text

GnuYak Industries is considering a new project that will lastfor three years. This project requires an initial investment in amachine that costs £90,000 immediately (year 0) and will bedepreciated in straight line over its three-year life to a residualvalue of 0. The management expects this project will result insales of £100,000 and cost of goods sold will be 50% of sales eachyear. This project also requires a total net working capital of£10,000 in year 0 which will be fully recovered in year 3. GnuYakis in the 35% corporate tax bracket.a. Calculate the total Free Cash Flows for each year of this newproject.b. Suppose that the appropriate discount rate for this projectis 10%, calculate the NPV of this project.

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