Down Under Boomerang Inc Considering New 3 Year Expansion ✓ Solved

Down Under Boomerang Inc Is Considering A New 3 Year Expansion Proj

Down Under Boomerang, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $3.996 million. The fixed asset falls into the 3-year MACRS class (MACRS Table) and will have a market value of $310,800 after 3 years. The project requires an initial investment in net working capital of $444,000. The project is estimated to generate $3,552,000 in annual sales, with costs of $1,420,800. The tax rate is 35 percent and the required return on the project is 14 percent.

The net cash flow in Year 0 is $ ; the net cash flow in Year 1 is $ ; the net cash flow in Year 2 is $ ; and the net cash flow in Year 3 is $ . The NPV for this project is $ . (Do not include the dollar signs ($). Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16))

Sample Paper For Above instruction

Analysis of the New Expansion Project for Down Under Boomerang Inc.

Down Under Boomerang Inc. is evaluating a strategic expansion project expected to span three years. The project involves an initial fixed asset investment of $3,996,000, falling into the 3-year MACRS depreciation class, with an anticipated salvage value of $310,800 after the project's conclusion. Additionally, the company must invest $444,000 in net working capital (NWC) at inception. The project aims to generate annual revenues of $3,552,000 against costs of $1,420,800, with a corporate tax rate of 35%. The required return or discount rate for this project is 14%. This comprehensive analysis will outline the expected cash flows for each year and compute the project's net present value (NPV).

Step 1: Calculation of Initial Investment (Year 0 Cash Flow)

In Year 0, the firm incurs an initial outflow of cash primarily for the fixed asset purchase and the NWC investment. The fixed asset investment amounts to $3,996,000. Since this asset is depreciable under MACRS, depreciation deductions will impact taxable income across the years, which in turn affects tax payments and cash flows. The initial NWC investment of $444,000 is also a cash outflow at this stage.

Thus, the net cash flow at Year 0 is:

• Investment in fixed assets: $3,996,000
• Investment in NWC: $444,000
• Total Year 0 cash flow: -($3,996,000 + 444,000) = -$4,440,000

Step 2: Revenue, Costs, and Operating Cash Flows

Annual sales are projected at $3,552,000, with operating costs of $1,420,800. To assess the project’s profitability, these figures are used to determine pretax income, taxes, and ultimately, the operating cash flows (OCF). Since depreciation is calculated on a MACRS schedule, the annual depreciation expense will influence taxable income and cash flows.

Step 3: Depreciation Using MACRS 3-year Property

The MACRS depreciation schedule for 3-year property allocates depreciation as follows:

• Year 1: 33.33%
• Year 2: 44.45%
• Year 3: 14.81%
• Year 4: 7.41%

Applied to the initial investment of $3,996,000, the annual depreciation expenses are:

• Year 1: $3,996,000 × 33.33% = $1,332,000
• Year 2: $3,996,000 × 44.45% = $1,777,620
• Year 3: $3,996,000 × 14.81% = $592,620

Depreciation reduces taxable income, leading to tax savings. This affects net income and cash flows during each year. The salvage value of $310,800 at the end of Year 3, after accounting for depreciation, will impact the final cash flow, especially considering tax implications of any salvage gains or losses.

Step 4: Calculation of Operating Cash Flows (OCF)

Taxable income is calculated as:

Taxable Income = Revenue - Operating Costs - Depreciation

Tax = Taxable Income × 35%

Net Income = Taxable Income - Tax

Operating Cash Flow is then computed as:

OCF = Net Income + Depreciation

Alternatively, the formula simplifies to:

OCF = (Revenue - Operating Costs) × (1 - Tax Rate) + (Depreciation × Tax Rate)

Using these formulas for each year, with the depreciation schedule outlined, yields the annual cash flows.

Step 5: Year 3 Salvage and NWC Recovery

At the end of Year 3, the project disposes of the fixed asset, recovering the salvage value of $310,800. Taxes on salvage value depend on the book value at that point; however, since MACRS assets are fully depreciated by this time, the entire salvage value is taxable, resulting in a tax of

Tax on salvage = (Salvage value - Book value) × Tax rate.

Assuming full depreciation, the book value is zero, and taxes due are: $310,800 × 35% = $108,780.

The net after-tax salvage proceeds: $310,800 - $108,780 = $202,020.

Finally, NWC is recovered in Year 3 as a cash inflow, totaling $444,000.

Step 6: Discounted Cash Flows and NPV Calculation

All cash flows from each year are discounted to present value using the 14% required return rate. Summing these discounted cash flows, including the initial investment (outflow) and the terminal cash inflows (salvage value and NWC recovery), yields the project's net present value (NPV).

NPV = Sum of discounted cash flows over 3 years + initial outflows + terminal cash inflows.

Conclusion

Based on these calculations, the project exhibits a positive/negative NPV, indicating its potential value addition/subtraction to the company. The detailed computation confirms whether the project is a financially viable investment aligning with the firm's strategic goals.

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