Oakmont Company has an opportunity to manufacture and sell a new product for a f
ID: 2478195 • Letter: O
Question
Oakmont Company has an opportunity to manufacture and sell a new product for a four-year period. The company's discount rate is 18%. After careful study, Oakmont estimated the following costs and revenues for the new product: When the project concludes in four years the working capital will be released for investment elsewhere within the company. Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables. Required: Calculate the net present value of this investment opportunity. (Use the appropriate table to determine the discount factor(s).)Explanation / Answer
The cash outflow of the project of Oakmont Company is as under:
Cost of equipment $220,000
Working capital $ 70,000
Overhaul of equipment(in 2nd year)($6,000×0.718) $ 4,308
Total cash outflow $294,308
Annual revenue to be earned by the project:
Sales $350,000
Less: Variable exp. ($170,000)
Contribution margin $180,000
Less: Fixed cost ($80,000)
Earnings $100,000
The net present value of the investment would be as under:
Net present value = present value of cash inflow-present value of cash outflow
Present value of cash inflow=$100,000 (cumulative present value for four years at a discounting rate of 18%)+ working capital released at the end of fourth year($70,000 * present value of fourth year at a discounting rate of 18%)+ salvage value of equipment ($17,000* present value of fourth year at a discounting rate of 18%)
Present value of cash inflow= ($100,000×2.69) + ($70,000×0.5158) + ($17,000×0.5158)
=$269,000+$36,106+$8,769
=$313,875
Net present value= ($313,875-$294,308)
= $19,567
The net present value of investment opportunity is $19,567.
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