NPV

CFA Level I
#1

An analyst gathered the following data about a project: • Costs are $8,000 plus $2,000 in shipping and installation. • For the next five years the project will annually generate $5,000 in sales and $2,000 in costs, not including depreciation. • The project is being depreciated on a straight-line basis over five years with no salvage value. • The company’s tax rate is 40%, and the weighted average cost of capital is 10%. The project’s net present value (NPV) is closest to: A. -$144. B. $144. C. $279. D. $1,244. ANswer A Using CF on the calculator, CFo = -ve 10000 CF1 to CF5 = (5000-2000-2000) = 1000 I = 10% Compute NPV? What am i missing here?

#2

Forgot to tax the income and to add back depreciation when calculating CF1-5

#3

So CF1 to CF5 = (5000-2000)*(1-0.4) + 2000 = 3800?

#4

No, (5000-2000-2000)*(1-0.4)+2000=2600

#5

thanks!

#6

I’m not seeing where they took out depreciation for you to add it back in.

#7

In my notes it says: In addition, accting net income must be adjusted for the cost of debt financing (interest expense), which has been subtracted in order to determine net income. So basically you have to add back in depreciation and interest expense before inputting the payments? Also Map1: (5000-2000-2000)*(1-0.4)+2000=2600 If Depr was taken out why don’t you put it back in before taxing it the income? Thanks

#8

This one is as simple as it gets: think of an income statement, start with Sales and deduct all expenses, get to EBT, apply taxes, obtain NI. When calculating CFO, start with NI and add back depreciation because it is a non-cash expense. Cost of the project on the balance sheet: 8k+2k=10k Depreciation, on a 5 year project life, SL with no salvage value, 10k/5=2k start with sales, deduct expenses and depreciation: 5k-2k-2k=1k, that would be EBT. Apply taxes, your “NI” from the project would be 1k*(1-0.4)=0.6K, add back depreciation because it is a noncash charge, that’s your CF, 2k+0.6k=2.6k.

#9

okay I got it. I forgot companies leave depreciation in there to have a lower taxable income then they add it back in after tax to have a higher net income. Thanks man.

#10

You mean to have higher CFO, not NI.

#11

yea that’s what I mean’t. sorry and thanks for the help

#12

Lower taxable income? Depreciation is always adjusted back in the tax section. I thought the depreciation should be adjusted back to calculate taxable income?