Modern Flooring is considering a new product line. The new line would require $134,000 of fixed assets and net working capital of $24,000. The firm will apply straight-line depreciation to a zero salvage value over three years. The new line is expected to produce an operating cash flow of $35,000 the first year with that amount decreasing by 10 percent annually for two years before the new line will be discontinued. The fixed assets can be sold for $25,000 at the end of the project and all net working capital will be recovered. What is the net present value of the new line at a discount rate of 11.5 percent and a tax rate of 35 percent

-51,784

Explanation:

Net present value can be calculated by first calculating the present values of operating cash flows each year and the sum up all the present values.

Year                                    0                1             2              3

Operating CF                                    35000    31500     28350

Fixed asset                  -134000

Net working capital     -24000                                       24000

Disposal after tax                                                             16250

(25000x0.65)

Net cashflow                -158000       35000    31500    68600

PV Factor                           1               0.896     0.804      0.721

PV                                -158000        31390       25337     49488

NPV =  -158000  + 31390 + 25337  + 49488

NPV = -51,784

Workings

PV Factor

Year 0  =   1/(1.115)^0 = 1

Year 1  =   1/(1.115)^1 = 0.896          

Year 2  =   1/(1.115)^2 = 0.804

Year 3  =   1/(1.115)^3 = 0.721

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