Emperor’s Clothes Fashions can invest $6 million in a new plant for producing in

Question

Emperor’s Clothes Fashions can invest $6 million in a new plant for producing invisible makeup. The plant has an expected life of 5 years, and expected sales are 7 million jars of makeup a year. Fixed costs are $1.8 million a year, and variable costs are $2.50 per jar. The product will be priced at $3.40 per jar. The plant will be depreciated straight-line over 5 years to a salvage value of zero. The opportunity cost of capital is 12%, and the tax rate is 40%.

What is NPV if fixed costs turn out to be $1.6 million per year? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

Explanation / Answer

Initial Investment = $6 million
Useful Life = 5 years

Annual Depreciation = $6 million / 5
Annual Depreciation = $1.20 million

Annual OCF = [(Selling Price - Variable Costs per unit) * Sales Volume - Fixed Costs] * (1 - tax) + tax * Annual Depreciation
Annual OCF = [($3.40 - $2.50) * 7 million - $1.60 million] * (1 - 0.40) + 0.40 * $1.20 million
Annual OCF = $4.70 million * 0.60 + 0.40 * $1.20 million
Annual OCF = $3.30 million

NPV = -$6.00 million + $3.30 million * PVIFA(12%, 5)
NPV = -$6.00 million + $3.30 million * (1 - (1/1.12)^5) / 0.12
NPV = -$6.00 million + $3.30 million * 3.6048
NPV = $5.90 million

So, NPV of this project is $5.90 million

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