Expansion Project Example
Dr. C. Bulent Aybar
Professor of International Finance
• The Gomez Co. is considering an investment project. Gomez has
sufficient excess capacity in its plant to take on the project by making an
investment in additional new equipment.
• The investment in land is $2 million; in plant is $8 million, subject to
MACRS depreciation at 3 percent per year. The equipment cost is $10
million, and it qualifies in the five-year asset class under MACRS
depreciation.
• The investment is expected to be completed at the end of 2014, and first
project cash flows are expected to be generated at the end of 2015.
• The project life is six years over the years 2015 through 2020.
• Expected sales and unit sales price are given as follows:
© Dr. C. Bulent Aybar
Case Data
Investment Outlay Sales Sales Price (Real
Land 2,000,000 Volume Units USD)
Plant 8,000,000 2015 10,000.00 1,000
2016 14,000.00 1,000
2017 20,000.00 1,000
Equipment 10,000,000
2018 25,000.00 1,000
2019 28,000.00 1,000
NWC Investment 800,000 2020 30,000.00 1,000
• The sales price per unit in 2015 real dollars will be $1,000 for each of
the years. Cash operating costs are projected at 75% of sales.
• The applicable tax rate for Gomez is 34%.
• The project will require an initial working capital investment of
$800,000 in 2014 and during the operational period net working capital
will be 10% of sales.
• For instance, if Gomez’s expected sales in 2015 is $10,000,000, working
capital requirement will be $1,000,000 and company will have to invest
$200,000 in its net working capital to support its operations. Thereafter
the incremental investment in in net working capital each year will
be 10% of the sales increase.
• The total networking capital investment will be recovered at the end of
the sixth year.
© Dr. C. Bulent Aybar
• Although no salvage value is taken into account in
calculating MACRS depreciation , Gomez forecasts
that the equipment will have a salvage value of $1
million at the end of 2020.
Column1 Land Building Equipment Total Salvage Value
Salvage values 2020 (2014 real dollars) $2,000,000 $6,680,000 $1,000,000
Initial cost 2,000,000 8,000,000 10,000,000
Depreciable basis 2014 0 8,000,000 10,000,000
Book value, 2020 2,000,000 6,680,000 0
Gain/Loss 0 0 1,000,000
Tax Liability/Credit 0 0 340,000
Net salvage values 2,000,000 6,680,000 660,000 9,340,000.00
© Dr. C. Bulent Aybar
Project Cash Flows
2014 2015 2016 2017 2018 2019 2020
Investment Outlay 0 1 2 3 4 5 6
Property, Plant & Equipment (20,000,000)
NWC (800,000)
Total Outlay (20,800,000)
Unit Sales 10,000 14,000 20,000 25,000 28,000 30,000
Sales Price Real 1,000 1,000 1,000 1,000 1,000 1,000
Inflation 0%
Sales Price Nominal 1,000 1,000 1,000 1,000 1,000 1,000
Net Sales 10,000,000 14,000,000 20,000,000 25,000,000 28,000,000 30,000,000
Cash Operating Costs 7,500,000 10,500,000 15,000,000 18,750,000 21,000,000 22,500,000
EBITDA 2,500,000 3,500,000 5,000,000 6,250,000 7,000,000 7,500,000
Depreciation on Equipment 2,000,000 3,200,000 1,900,000 1,200,000 1,100,000 600,000
Depreciation on Building 240,000 240,000 240,000 240,000 240,000 240,000
Income Before Taxes 260,000 60,000 2,860,000 4,810,000 5,660,000 6,660,000
Tax (@34%) 88,400 20,400 972,400 1,635,400 1,924,400 2,264,400
Income After Tax 171,600 39,600 1,887,600 3,174,600 3,735,600 4,395,600
Depreciation 2,240,000 3,440,000 2,140,000 1,440,000 1,340,000 840,000
Change in NWCI (200,000) (400,000) (600,000) (500,000) (300,000) (200,000)
Cumulative NWCI (1,000,000) (1,400,000) (2,000,000) (2,500,000) (2,800,000) (3,000,000)
Net Salvage Values - - - - - 9,340,000
Total Cash Flows (20,800,000) 2,211,600 3,079,600 3,427,600 4,114,600 4,775,600 17,375,600
Project Evaluation: NPV and IRR
Real Cost of Capital 7%
Inflation 0
Nominal Cost of Capital 0.07
NPV 4,876,741.78
IRR 12.24%
Project Cash Flows under 5% Inflation Assumption
2014 2015 2016 2017 2018 2019 2020
Investment Outlay 0 1 2 3 4 5 6
Property, Plant & Equipment (20,000,000)
NWC (800,000)
Total Outlay (20,800,000)
Unit Sales 10,000 14,000 20,000 25,000 28,000 30,000
Sales Price Real 1,000 1,000 1,000 1,000 1,000 1,000
Inflation 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%
Sales Price Nominal 1,000 1,050 1,103 1,158 1,216 1,276
Net Sales 10,000,000 14,700,000 22,050,000 28,940,625 34,034,175 38,288,447
Cash Operating Costs 7,500,000 11,025,000 16,537,500 21,705,469 25,525,631 28,716,335
EBDIT 2,500,000 3,675,000 5,512,500 7,235,156 8,508,544 9,572,112
Depreciation on Equipment 2,000,000 3,200,000 1,900,000 1,200,000 1,100,000 600,000
Depreciation on Building 240,000 240,000 240,000 240,000 240,000 240,000
Income Before Taxes 260,000 235,000 3,372,500 5,795,156 7,168,544 8,732,112
Tax (@34%) 88,400 79,900 1,146,650 1,970,353 2,437,305 2,968,918
Income After Tax 171,600 155,100 2,225,850 3,824,803 4,731,239 5,763,194
Depreciation 2,240,000 3,440,000 2,140,000 1,440,000 1,340,000 840,000
Change in NWCI (200,000) (470,000) (735,000) (689,063) (509,355) (425,427)
Cumulative NWCI (1,000,000) (1,470,000) (2,205,000) (2,894,063) (3,403,418) (3,828,845)
Net Salvage Values - - - - - 11,512,803
Total Cash Flows (20,800,000) 2,211,600 3,125,100 3,630,850 4,575,741 5,561,884 21,519,414
Real Cost of Capital 7%
Inflation 5%
Nominal Cost of Capital 12.35%
NPV 2,883,803.49
IRR 15.70%
Salvage Values with Inflation
Column1 Land Building Equipment Total Salvage Value
Initial Investment 2,000,000 8,000,000 10,000,000
Salvage Value 2,680,191 8,951,839 1,340,096
Book Value in 2020 2,000,000 6,680,000 -
Capital Gain/Loss at Liquidation 680,191 2,271,839 1,340,096
Taxes 231,265 772,425 455,633
Net Salvage Value 2,448,926 8,179,414 884,463 11,512,803
Project NPV and IRR
Real Cost of Capital 7%
Inflation 5%
Nominal Cost of Capital 12.35%
NPV 2,883,803.49
IRR 15.70%