Hope Corporation is considering an expansion project. The proposed project has t

Question

Hope Corporation is considering an expansion project. The proposed project has the following features:

The project has an initial cost of $1,000,000 (machine: $800,000, insurance: $40,000, shipping $60,000, modification: $100,000) --this is also the amount which can be depreciated using the following 5 year MACRS depreciation schedule:

Year          Depreciation Rate

1                           20%

2                           32

3                           19.20

4                           11.52

5                           11.52

6                           5.76

The sales price is expected to increase by 2 percent per year due to inflation.

The variable cost is expected to increase by 3 percent per year.

The fixed cost will be $50,000 per year for the next five years. (No fixed cost increase)

Number of units sold will grow by 5 percent every year.

If the project is undertaken, net working capital would have to increase by an amount equal to 10% of sales revenues. This net operating working capital will be recovered at the end of the project’s life (t = 5). (You must consider an inflation effect.)

If the project is undertaken, the company will sell additional 200,000 units in year one (t = 1). Unit price at the end of the Year 1 is $10.

Unit price is $10 and variable unit cost is $4 at the end of the Year 1.

The company’s tax rate is 30 percent.

The company has no debt.

At the end of Year 5, the project’s economic life is complete, but the company can sell the machine at $20,000 (market value of salvage).

The project’s WACC = 10 percent.

Calculate NPV using Excel.

Using “Owo Way Data Table” of the Excel, show the sensitivity of the NPV of the project to the growth rate of units sold per year (Use the growth rate from 0% to 10% in 1% increment)

Explanation / Answer

Initial Outflow= $ 1000000 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Depreciation rate 20% 32% 19.20% 11.52% 11.52% 5.76% Depreciation Amount in $ 200000 320000 192000 115200 115200 57600 Tax Saving on Dep @ 30% 60000 96000 57600 34560 34560 17280 Book value of Machinery after 5 year = $ 1000000- $942400 = $ 57600 Loss on Sale of machinery = $ 57600- $ 20000 = $ 37600 Tax Saving on Dep= $ 37600 X 30% = $ 11280 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Initial outflow     -10,00,000 Working Capital Requirement 10% of Increase in Sales in year before       -2,00,000             -14,200             -15,208             -16,288               -17,444             2,45,696 Sales 200000 additional Unit @ $ 10 per unit (increase price by 2% and Qty 5% YOY)         20,00,000         21,42,000        22,94,082          24,56,962          26,31,406 Variable cost 200000 additional Unit @ $ 4 per unit (increase cost by 3% and Qty 5% YOY)         -8,00,000         -8,65,200         -9,35,714         -10,11,974         -10,94,450 Fixed Cost             -50,000             -50,000             -50,000               -50,000               -50,000 Tax Saving on Depreciation               60,000               96,000              57,600                34,560                34,560 Sale of Machinery                20,000 Tax Saving on Loss of Machinery                11,280 Tax on Margin @ 30% ( Sale-VC-Fixed Cost)         -3,45,000         -3,68,040         -3,92,510           -4,18,496           -4,46,087 Net Cash Flow     -12,00,000           8,50,800           9,39,552           9,57,170             9,93,607          13,52,405 Discount factor @ 10% 1                   0.91                   0.83                   0.75                     0.68                     0.62 Discounted Cash flow     -12,00,000           7,73,455           7,76,489           7,19,136             6,78,647             8,39,737 25,87,463 NPV of the project       25,87,463

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