📊 Capital Budgeting: Full Calculation Quiz

Project: Smoothie Stand Evaluation

Initial Equipment Cost: $110,000
Installation Cost: $12,000
Increase in Inventory (Working Capital): $9,000
Increase in Accounts Payable: $4,000
Project Life: 5 years
Salvage Value at Year 5: $18,000
Tax Rate: 25%
Discount Rate (WACC): 9%
Depreciation: Straight-line over 5 years, no salvage for depreciation
Annual Revenue: $95,000
Annual Operating Costs (excluding depreciation): $55,000

Q1. What is the initial investment outlay for the project?

Solution:
Initial Outlay = Equipment + Installation + Net Working Capital Increase
= 110,000 + 12,000 + (9,000 - 4,000) = $127,000

Q2. What is the annual depreciation expense?

Solution:
Depreciable Base = 110,000 + 12,000 = 122,000
Depreciation = 122,000 / 5 = $24,400 per year

Q3. What is the Year 1 operating cash flow (OCF)?

Solution:
EBIT = Revenue - Operating Costs - Depreciation
= 95,000 - 55,000 - 24,400 = 15,600
Taxes = 15,600 × 25% = 3,900
OCF = EBIT + Depreciation - Taxes = 15,600 + 24,400 - 3,900 = $36,100

Q4. What are the terminal year cash flows, and how are they calculated?

Solution:
After-tax Salvage = $18,000 × (1 - 0.25) = 13,500
Recovery of Net Working Capital = $5,000 (inventory - A/P)
Terminal Year CF = OCF + Salvage After Tax + WC Recovery
= 36,100 + 13,500 + 5,000 = $54,600

Q5. What is the Net Present Value (NPV) of the project?

Solution:
OCF = 36,100 (Years 1–4)
Terminal Year CF = 54,600 (Year 5)
WACC = 9%
NPV = -127,000 + 36,100 × PVIFA(9%, 4) + 54,600 × PVIF(9%, 5)
PVIFA(9%, 4) ≈ 3.2397, PVIF(9%, 5) ≈ 0.6499
NPV = -127,000 + (36,100 × 3.2397) + (54,600 × 0.6499)
= -127,000 + 116,964.57 + 35,480.54 = $25,445

Q6. Final Decision?

Decision:
Since NPV > 0, accept the project. It adds value to the firm.