1. A project requires an initial investment of $20,000,000. The life of the project is 3 years. The $20,000,000 investment will be depreciated using the three-year modified accelerated cost recovery system (MACRS) class (see the table below). The firm estimates that, in the first year, the revenues and total production costs will be $60,000,000 and $45,000,000, respectively, in nominal terms. After that the sales and production costs are expected to increase at the inflation rate of 4 percent per year over the life of the project. In addition, it has a before-tax salvage value (or resale value) at the end of the project of $9,000,000. The mine will require a networking capital (NWC) investment of 7 percent of sales. The NWC will be built up in the year prior to the sales (e.g., the net working capital requirement for year O is 7% of sales in year 1 and the additional net working capital cash flow for year 1 is 7% of the difference in sales between year 2 and year 1). All net working capital cash flows are fully recoverable when the project ends. The tax rate is 25 percent. The project only depreciates the $20,000,000 initial cost. The salvage value is excluded from depreciation. a) Find the operating cash flow (OCF) of this project for each year. b) If the real discount rate (or required rate of return) of the project is 14 percent, what is its net present value (NPV)? Year MACRS Depreciation Allowances for 3-year Recovery Period Class 33.33% 44.44% 1 2 3 14.82% 4 7.41% 1. A project requires an initial investment of $20,000,000. The life of the project is 3 years. The $20,000,000 investment will be depreciated using the three-year modified accelerated cost recovery system (MACRS) class (see the table below). The firm estimates that, in the first year, the revenues and total production costs will be $60,000,000 and $45,000,000, respectively, in nominal terms. After that the sales and production costs are expected to increase at the inflation rate of 4 percent per year over the life of the project. In addition, it has a before-tax salvage value (or resale value) at the end of the project of $9,000,000. The mine will require a networking capital (NWC) investment of 7 percent of sales. The NWC will be built up in the year prior to the sales (e.g., the net working capital requirement for year O is 7% of sales in year 1 and the additional net working capital cash flow for year 1 is 7% of the difference in sales between year 2 and year 1). All net working capital cash flows are fully recoverable when the project ends. The tax rate is 25 percent. The project only depreciates the $20,000,000 initial cost. The salvage value is excluded from depreciation. a) Find the operating cash flow (OCF) of this project for each year. b) If the real discount rate (or required rate of return) of the project is 14 percent, what is its net present value (NPV)? Year MACRS Depreciation Allowances for 3-year Recovery Period Class 33.33% 44.44% 1 2 3 14.82% 4 7.41%
