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Louie's Leisure Products is considering a project which will require the purchase of $1,4 million in new equipment
Louie's Leisure Products is considering a project which will require the purchase of $1,4 million in new equipment. The equipment belongs in a 20% CCA class. Louie's expects to sell the equipment at the end of the project for 20% of its original cost. Annual sales from this project are estimated at $1.2 million Networking capital equal to 20% of sales will be required to support the project. All of the networking capital will be recouped at the end of the project. The firm desires a minimal 14% rate of return on this project. The tax rate is 34% What is the present value of the networking capital changes associated with the project? The project is expected to last 7 years. Multiple Choice $144 087
Expert Solution
Here is the calculation:
| year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
| sales | 1200000 | 1200000 | 1200000 | 1200000 | 1200000 | 1200000 | 1200000 | |
| Working capital | 0 | 240000 | 240000 | 240000 | 240000 | 240000 | 240000 | 240000 |
| Working capital change | -240000 | 240000 | ||||||
| Present value (PV) | -240000 | 95913 | ||||||
| NPV | -144087 |
Genrally, in NPV calculations, any working capital change required are taken in year 0 itself.
so, WC required in year 0 = WC in year 1 - WC in year 0 = -240,000
as per the question, this entire 24000 is recouped at the end of year 7.
So, NPV = -240,000 + PV of 240,000 to be received in year 7 = -240,000 + 240,000 / (1.14^7) = -144,087
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