How do you set up the NPV/Cashflows for this assignment
MacDonald Publishing is considering entering a new line of business. In analyzing the potential business, their financial staff has accumulated the following information:
The new business will require a capital expenditure of $5 million at t = 0. This expenditure will be used to purchase new equipment.
This equipment will be depreciated according to the following depreciation schedule:
MACRS
Depreciation
Year Rates
1 0.33
2 0.45
3 0.15
4 0.07
The equipment will have no salvage value after four years.
If MacDonald goes ahead with the new business, inventories will rise by $500,000 at t = 0, and its accounts payable will rise by $200,000 at t = 0. This increase in net operating working capital will be recovered at t = 4.
The new business is expected to have an economic life of four years. The business is expected to generate sales of $3 million at t = 1, $4 million at t = 2, $5 million at t = 3, and $2 million at t = 4. Each year, operating costs excluding depreciation are expected to be 75% of sales.
The company's tax rate is 40%.
The company's weighted average cost of capital is 10%.
The company is very profitable, so any accounting losses on this project can be used to reduce the company's overall tax burden.
What is the expected net present value (NPV) of the new business?