Poulsen Industries is analyzing an average-risk project, and the following data
ID: 2658353 • Letter: P
Question
Poulsen Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no salvage value. No change in net operating working capital would be required. This is just one of many projects for the firm, so any losses on this project can be used to offset gains on other firm projects. The marketing manager does not think it is necessary to adjust for inflation since both the sales price and the variable costs will rise at the same rate, but the CFO thinks an inflation adjustment is required. What is the difference in the expected NPV if the inflation adjustment is made versus if it is not made? Do not round the intermediate calculations and round the final answer to the nearest whole number WACC Net investment cost (depreciable basis) Units sold Average price per unit, Year 1 Fixed op. cost excl. depr. (constant) Variable op. cost/unit, Year 1 Annual depreciation rate Expected inflation Tax rate O a. $10,017 10.0% $200,000 38,000 $25.00 $150,000 $20.20 33.333% 4.00% 40.000 b.$9,707 C. $12,908 O d. $10,327 O e. $7,952Explanation / Answer
Computation of cash flows with inflation:
Year 1
Year 2
Year 3
Price per unit
$25.00
$26.00
$27.04
Variable cost per unit
$20.20
$21.01
$21.85
Unit sold
38,000
38,000
38,000
Sales
(price per unit x unit sold)
$950,000
$988,000
$1,027,520
Less: Total Variable Cost
(unit VC x unit sold)
$ 767,600
$798,304
830,236
Less: Fixed cost
$15,000
$15,000
$15,000
EBITDA
$167,400.00
$174,696.00
$182,283.84
Less: Depreciation ($200,000/3)
$66,666.67
$66,666.67
$66,666.67
EBIT
$100,733.33
$108,029.33
$115,617.17
Less: Tax @ 40 %
$40,293.33
$43,211.73
$46,246.87
Net income
$60,440.00
$64,817.60
$69,370.30
Add: Depreciation
$66,666.67
$66,666.67
$66,666.67
Net cash flow
$127,106.67
$131,484.27
$136,036.97
Computation of NPV:
Year
Cash Flow (C)
PV Factor calculation
PV Factor @ 10 % (F)
PV (= C x F)
0
$ (200,000)
1/(1+10%)^0
1
($200,000.00)
1
$ 127,106.67
1/(1+10%)^1
0.909090909
$115,551.52
2
$ 131,484.27
1/(1+10%)^2
0.826446281
$108,664.68
3
$ 136,037.97
1/(1+10%)^3
0.751314801
$102,206.59
NPV
$126,422.79
Without considering inflation, cash flow for year 1 through 3 will be $ 127,106.67
Computation of NPV without inflation:
Year
Cash Flow (C)
PV Factor calculation
PV Factor (F)
PV (= C x F)
0
$ (200,000)
1/(1+10%)^0
1
($200,000.00)
1
$ 127,106.27
1/(1+10%)^1
0.909090909
$115,551.52
2
$ 127,106.27
1/(1+10%)^2
0.826446281
$105,046.83
3
$ 127,106.27
1/(1+10%)^3
0.751314801
$95,497.12
NPV
$116,095.47
Difference in NPV = $ 126,422.79 - $ 116,095.47 = $ 10,327.32
Hence option “d. $ 10,327” is correct answer.
Year 1
Year 2
Year 3
Price per unit
$25.00
$26.00
$27.04
Variable cost per unit
$20.20
$21.01
$21.85
Unit sold
38,000
38,000
38,000
Sales
(price per unit x unit sold)
$950,000
$988,000
$1,027,520
Less: Total Variable Cost
(unit VC x unit sold)
$ 767,600
$798,304
830,236
Less: Fixed cost
$15,000
$15,000
$15,000
EBITDA
$167,400.00
$174,696.00
$182,283.84
Less: Depreciation ($200,000/3)
$66,666.67
$66,666.67
$66,666.67
EBIT
$100,733.33
$108,029.33
$115,617.17
Less: Tax @ 40 %
$40,293.33
$43,211.73
$46,246.87
Net income
$60,440.00
$64,817.60
$69,370.30
Add: Depreciation
$66,666.67
$66,666.67
$66,666.67
Net cash flow
$127,106.67
$131,484.27
$136,036.97
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