(Ignore income taxes in this problem.) Simpson Beauty Products Corporation is co
ID: 2415415 • Letter: #
Question
(Ignore income taxes in this problem.) Simpson Beauty Products Corporation is considering the production of a new conditioning shampoo that will require the purchase of new mixing machinery. The machinery will cost $700,000, is expected to have a useful life of 10 years, and is expected to have a salvage value of $70,000 at the end of 10 years. The machinery will also need a $45,000 overhaul at the end of Year 5. A $60,000 increase in working capital will be needed for this investment project. The working capital will be released at the end of the 10 years. The new shampoo is expected to generate net cash inflows of $150,000 per year for each of the 10 years. Simpson's discount rate is 18%.
Items
Year(s)
Amount
18% Factor
Present Value
Cost of machinery
Now
($700,000)
1
($700,000)
Working capital increase
Now
($60,000)
1
($60,000)
Annual cash inflows
1–10
$150,000
4.494
674,100
Overhaul
5
($45,000)
0.437
($19,665)
Salvage value
10
$70,000
0.191
13,370
Working capital release
10
$60,000
0.191
11,460
Net present value
($80,735)
Required:
(a) What is the net present value of this investment opportunity?
(b) Based on your answer to (a) above, should Simpson go ahead with the new conditioning shampoo?
Items
Year(s)
Amount
18% Factor
Present Value
Cost of machinery
Now
($700,000)
1
($700,000)
Working capital increase
Now
($60,000)
1
($60,000)
Annual cash inflows
1–10
$150,000
4.494
674,100
Overhaul
5
($45,000)
0.437
($19,665)
Salvage value
10
$70,000
0.191
13,370
Working capital release
10
$60,000
0.191
11,460
Net present value
($80,735)
Explanation / Answer
Answer a. Statement showing calculation of NPV Particulars Year Amount 18% Factor Present value C D C X D Cash Inflow Annual Cash Inflows 1 - 10 150,000 4.494 674,100 Working Capital Release 10 60,000 0.191 11,460 Salvage Value of Machinery 10 70,000 0.191 13,370 A. Total Cash Inflow - PV 698,930 Cash Outflow Cost of Machinery 0 700,000 1.000 700,000 Working Capital Requirement 0 60,000 1.000 60,000 Overhauling Cost 5 45,000 0.437 19,665 B. Total Cash Outflow - PV 779,665 NPV (A - B) (80,735) Answer b. NPV is negative, the company should not go ahead with the new conditioning shampoo
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