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Net Investment, Annual Net Cash Flows, NPV, Payback Period

I am looking for step-by-step instructions on how to set this problem up to solve for a through d on the attached. I can write it up and explain the reasoning but I'm stuck on how to solve. This is for my MBA finance class and the book gives more basic examples of NINV, cash flows, etc. Not sure what to do with so many factors involved in this problem. Thanks for any help with this.


Countywide Financing is fed up with collections. They are considering
the establishment of a new division to handle all collections for the
firm. Compensation to the new division will be based on the successful
collection(s) of outstanding delinquent debt(s).

The following table reflects the new divisions expected revenue: (SEE ATTACHED)

The projected life expectancy of this venture is seven (7) years.
Revenue receipts are expected to shrink at the rate of 8% per year
across the board.

Countywide will utilize existing space
available in their current headquarters. This space costs them $3.00 per
square foot per month and consists of 1800 square feet. Rent is
expected to increase at the rate of 2% per year for as long as
Countywide remains at this location. Other operating expenses (excluding
depreciation) add up to $300,000 for the first year with an expected
annual growth rate of 9% per year. Countywide will invest $825,000 in
net working capital for the new division and spend $425,000 on new
computers and office equipment. The new equipment will cost $15,000 to
install. The equipment will be depreciated over five (5) years using the
MACRS table (see At the end of the seven(7) year life
expectancy of the division, the salvage value of the equipment will be
$10,000. The marginal tax rate is expected to be 37% over the life of
the project and the average tax rate is expected to be 35% over the life
of the project. Countywide expects a minimum return of 12% from this

Determine the following and show your work where appropriate:

a. Net investment required to establish Countywide's new division.

b. Calculate the annual net cash flows over the life of the project.

c. Calculate the NPV of this project and determine if it is a viable venture.

d. Calculate the payback period and justify whether it is acceptable and why.


Solution Preview

OK, let's try to take it step by step:

First, we are looking for the net investment to begin the new division, so we are interested in:

* Rent is $3/foot x 1800/month x 12 = $64,800 (for the first year)
* other operational expenses x 12 = $300,000(for the first year)

* Net working capital investment = $825,000
* New computers & Eqpt = $425,000 + $15,000 to install = $440,000

A) So the net investment REQUIRED for the first year is the rent + the operating expenses for a total of $364,800 (but note there is an extra investment of $1,265,000) from the main company; resulting in a net over investment of $1,265,000 - $364,800 = $900,200.

B) Net annual cash flows over the life of the project:

Year One: $100 x 6200 = $620,000
$500 x 2400 = $1,200,000
$2000 x 550 = $1,100,000
$10,000 x 25= $250,000

Total collections year one = $ 3,170,000 (reducing by 8%/year for seven years)

Year 2 = 3,170,000 x .92 = 2,916,400
Year 3 = 2,916,400 x .92 = 2,683,088
Year 4 = 2,683,088 x .92 = 2,468,441
Year 5 = 2,468,441 x.92 = 2,270,966
Year 6 = 2,270,966 x.92 = 2,089,289
Year 7 = 2,089,289 x .92 = 1,922,146

Rent Year 1 = 64,800
Rent year 2 = 64,800 x 1.02 = ...

Solution Summary

Investing within a corporation requires calculating initial outlay, returns to be received over time, forecasting future revenue, forecasting costs, determining appropriate return on investment, and calculating the payback period. These are covered within this analysis in order to determine if an investment is acceptable for the corporation.