A company is considering launching a new product. It has ordered a feasibility s
ID: 2653515 • Letter: A
Question
A company is considering launching a new product. It has ordered a feasibility study at a cost of $300,000 to investigate the consequences of the investment. The study yielded the following information. Expected sales for the next four years are the following:
Year
Units Sold
1
63,000
2
70,000
3
78,000
4
60,000
The sales price of the new product is estimated at $200 per unit. The logistics department forecasts that net working capital requirements (NWC) will represent 20% of current year sales, and that NWC will be recovered in full in year 5. Variable costs per unit are estimated at $140, and there are annual fixed costs of $600,000 every year. Because of marketing synergies, the new product is expected to increase sales of existing products by $150,000 per year for the next 4 years.
This project requires an initial investment (machine) of $8 million that can be depreciated linearly over 8 years to zero book value. At the end of the project in year 4, the machine can be sold for 40% of the purchase price. Taxable income and capital gains are taxed at a fixed rate of 35%, and the required rate of return by investors is 16%. Compute the NPV of the project.
Year
Units Sold
1
63,000
2
70,000
3
78,000
4
60,000
Explanation / Answer
Statement showing calculation of NPV Particulars Time PVF Amount PV Cash Outflows (Initial Invt) - 1.0000 (8,000,000.00) (8,000,000.00) PV of Cash Outflows (8,000,000.00) Cash Inflows(Income) 1.00 0.8621 2,514,500.00 2,167,672.41 Cash Inflows(Income) 2.00 0.7432 2,787,500.00 2,071,566.59 Cash Inflows(Income) 3.00 0.6407 3,099,500.00 1,985,718.46 Cash Inflows(Income) 4.00 0.5523 2,397,500.00 1,324,117.91 Cash Inflows(Salvage Value) 4.00 0.5523 3,480,000.00 1,921,973.02 Cash Inflows(Change in Working cap) 1.00 0.8621 (2,520,000.00) (2,172,413.79) Cash Inflows(Change in Working cap) 2.00 0.7432 (280,000.00) (208,085.61) Cash Inflows(Change in Working cap) 3.00 0.6407 (320,000.00) (205,010.46) Cash Inflows(Change in Working cap) 4.00 0.5523 720,000.00 397,649.59 Cash Inflows(Change in Working cap) 5.00 0.4761 2,400,000.00 1,142,671.24 PV of Cash Inflows 8,425,859.35 NPV 425,859.35 Project should be accepted Note: Research cost of $300,000 is sunk cost thus ignored Year 1.00 2.0000 3.00 4.00 No of units Sold 63,000.00 70,000.0000 78,000.00 60,000.00 SP per unit 200.00 200.0000 200.00 200.00 Total Sales 12,600,000.00 14,000,000.0000 15,600,000.00 12,000,000.00 NWC@20% 2,520,000.00 2,800,000.0000 3,120,000.00 2,400,000.00 Change comp to prev year 2,520,000.00 280,000.0000 320,000.00 (720,000.00) VC per unit 140.00 140.0000 140.00 140.00 Cont per unit(SP per unit-VC per unit)(200-140) 60.00 60.0000 60.00 60.00 Total cont 3,780,000.00 4,200,000.0000 4,680,000.00 3,600,000.00 Fixed Costs 600,000.00 600,000.0000 600,000.00 600,000.00 Income 3,180,000.00 3,600,000.0000 4,080,000.00 3,000,000.00 Increase in sales of existing prod(Assuming all sales are income since nothing is specified in Question) 150,000.00 150,000.0000 150,000.00 150,000.00 Total income or cash flows before tax 3,330,000.00 3,750,000.0000 4,230,000.00 3,150,000.00 Tax@35% 1,165,500.00 1,312,500.0000 1,480,500.00 1,102,500.00 CFAT 2,164,500.00 2,437,500.0000 2,749,500.00 2,047,500.00 Depreciation 1,000,000.00 1,000,000.0000 1,000,000.00 1,000,000.00 Tax Savings on depr 350,000.00 350,000.0000 350,000.00 350,000.00 Total CFAT(CFAT+Tax savings on depr) 2,514,500.00 2,787,500.0000 3,099,500.00 2,397,500.00 Depreciation for first 4years(8000000/8) 1,000,000.00 Value at end of 4 years(8000000-4000000) 4,000,000.00 Sale price(8000000*40%) 3,200,000.00 Loss on Sale 800,000.00 Tax Savings on Loss@35% 280,000.00 Net Cash flows from Sale(3200000+280,000) 3,480,000.00
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