Mustang Enterprises, Inc., has been considering the purchase of a new manufactur
ID: 1174656 • Letter: M
Question
Mustang Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $280,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $115,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 2 percent. Production costs at the end of the first year will be $40,000, in nominal terms, and they are expected to increase at 3 percent per year. The real discount rate is 5 percent. The corporate tax rate is 40 percent. Calculate the NPV of the project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Please don't post some of those old answers because none of them are correct.
Explanation / Answer
NPV = $159,803.23
………….
Working:
Nominal rate for discounting = (1+real rate) x (1+inflation rate)-1
Nominal rate for discounting = (1+5%) x (1+2%)-1
Nominal rate for discounting = 7.10%
Year
Cash outflows
Cash inflows
Depreciation = D = 280000/7 = 40000
Net cash flow* = (CF-D)x(1-Tax rate)+D+WC
Discount factor = Df = 1/(1+Rate)^Year
Present Values
Co
Ci
D
(Co+Ci-D)x(1-40% rate)+D
Df = 1/(1+7.1%)^Year
Df x Net Cash flows
0
-280000.00
0.00
0.00
-280,000.00
1.000000
-280,000.00
1
-40,000.00
115,000.00
40,000.00
61,000.00
0.999291
60,956.75
2
-41,200.00
117,300.00
40,000.00
61,660.00
0.998582
61,572.57
3
-42,436.00
119,646.00
40,000.00
62,326.00
0.997873
62,193.43
4
-43,709.08
122,038.92
40,000.00
62,997.90
0.997165
62,819.30
5
-45,020.35
124,479.70
40,000.00
63,675.61
0.996458
63,450.07
6
-46,370.96
126,969.29
40,000.00
64,359.00
0.995751
64,085.54
7
-47,762.09
129,508.68
40,000.00
65,047.95
0.995044
64,725.57
Total = NPV =
159,803.23
Year
Cash outflows
Cash inflows
Depreciation = D = 280000/7 = 40000
Net cash flow* = (CF-D)x(1-Tax rate)+D+WC
Discount factor = Df = 1/(1+Rate)^Year
Present Values
Co
Ci
D
(Co+Ci-D)x(1-40% rate)+D
Df = 1/(1+7.1%)^Year
Df x Net Cash flows
0
-280000.00
0.00
0.00
-280,000.00
1.000000
-280,000.00
1
-40,000.00
115,000.00
40,000.00
61,000.00
0.999291
60,956.75
2
-41,200.00
117,300.00
40,000.00
61,660.00
0.998582
61,572.57
3
-42,436.00
119,646.00
40,000.00
62,326.00
0.997873
62,193.43
4
-43,709.08
122,038.92
40,000.00
62,997.90
0.997165
62,819.30
5
-45,020.35
124,479.70
40,000.00
63,675.61
0.996458
63,450.07
6
-46,370.96
126,969.29
40,000.00
64,359.00
0.995751
64,085.54
7
-47,762.09
129,508.68
40,000.00
65,047.95
0.995044
64,725.57
Total = NPV =
159,803.23
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