Aday Acoustics, Inc., projects unit sales for a new seven-octave voice emulation

Question

Aday Acoustics, Inc., projects unit sales for a new seven-octave voice emulation implant as follows: Year Unit Sales 1 77,000 2 90,000 3 104,000 4 99,000 5 80,000 Production of the implants will require $1,560,000 in net working capital to start and additional net working capital investments each year equal to 20 percent of the projected sales increase for the following year. Total fixed costs are $1,460,000 per year, variable production costs are $245 per unit, and the units are priced at $360 each. The equipment needed to begin production has an installed cost of $20,600,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS property. In five years, this equipment can be sold for about 25 percent of its acquisition cost. The company is in the 30 percent marginal tax bracket and has a required return on all its projects of 19 percent. MACRS schedule. What is the NPV of the project?

Explanation / Answer

Answer: This is an in-depth capital budgeting problem. We will use the bottom up approach, so we will need to construct an income statement for each year. Beginning with the initial cash flow at time zero, the project will require an investment in equipment. The project will also require an investment in NWC. The NWC investment will be 20 percent of the next year’s sales. In this case, it will be Year 1 sales. Realizing we need Year 1 sales to calculate the required NWC capital at time 0, we find that Year 1 sales will be $27,720,000. So, the cash flow required for the project today will be:

Capital Spending=5150000+(4595860-5150000)*0.30

=4983758

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