Introduction to Finance

Initial Investment Outlay
To increase production to meet the city’s request and to modify 
the cycles for police use, the fi rm’s plant and equipment will need to be expanded at a cost of 
TA B L E L E 1 7 . 6
Cash Flow Summary and NPV Calculation
Year
Initial 
Outlay
Operating 
Cash Flows
Salvage 
Value
Total 
Incremental 
Cash Flows
PVIF 
(10%)
PV of 
Cash 
Flows
0
–$8,400
$0
$0
$8,400
1.0000
–$8,400
1
0
2,300
0
2,300
0.9091
2,091
2 
0
1,700
0
1,700
0.8264
1,405
3
0
1,400
600
2,000
0.7513
1,503
NPV = –$3,401

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562
C H A PT E R 1 7 Capital Budgeting Analysis
$120,000 this year. It will cost about $10,000, after taxes, to hire and train new workers. Net 
working capital needs are expected to increase $40,000 this year. The fi rm will recover this 
increase in net working capital in the third year as it fi lls the production requirement.
This brings the total investment to $170,000, including $120,000 in depreciable assets. 
These assets will be straight-line depreciated over the three years of the project’s life; thus, 
depreciation expense is expected to be $120,000∕3, or $40,000 per year.
If the fi rm wins the bid, labor costs are expected to rise by $50,000 per year. Raw mater-
ials expenses will rise by $20,000 per year. Thus, expenses will increase by $70,000 annually 
as a result of this project.
Salvage Value
The salvage value of the specialized equipment needed for this project 
is expected to be only $20,000 after three years. Since the assets will be fully depreciated 
to a book value of $0 at the end of three years, the after-tax proceeds from their sale will be 
$20,000 – 0.4($20,000 – $0) = $12,000.