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A project requires the purchase of $587,000 of equipment that will be depreciated straight-line to a zero book value over the four-year life of the project. The equipment can be scraped at the end of the project for 33 percent of its original cost. Annual sales from this project are estimated at $625,000 with cash expenses of $487,000. Net working capital equal to 12 percent of sales will be required to support the project. The required return is 13 percent and the tax rate is 21 percent. What is the cash flow in Year 2 of the project? (Ignore bonus depreciation.)

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Answer:

The cash inflows in Year 2 is: $6,750

The present value of the project in Year 2 is: $5,286 (ignored the depreciation)

The Net Present Value in Year 2 is: $-642,112 (required return rate is 13%)

Explanation: (See the attached table also)

1. Initial investment: $587,000

2. Year 1:

- Sales: $625,000

- Cash expense: $487,000

- Money to support project: $625,000 x 12% = $75,000

- Tax to pay: $625,000 x 21% = $131,250

=> Cash inflow in Year 1:

            625,000 - 487,000- 75,000 - 131,250 = - 68,250

Present value: -68,250 : (1+0.13) = -60,398

NPV: -60,398 - 587,000 = - 647,398

Year 2:

- Capital from year 1: $75,000

- Sales: $625,000

- Cash expense: $487,000

- Money to support project: $625,000 x 12% = $75,000

- Tax to pay: $625,000 x 21% = $131,250

=> Cash inflow in Year 2:

      75,000 + 625,000 - 487,000- 75,000 - 131,250 = 6,750

Present value: 6,750 : [(1+0.13)^2] = 5,286

NPV year 2 = NPV Year 1 + PV Year 2 = -647,398 + 5,286 = -641, 112

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