We are evaluating a project that costs $724,000, has an eight-year life, and has

Question

We are evaluating a project that costs $724,000, has an eight-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 75,000 units per year. Price per unit is $39, variable cost per unit is $23, and fixed costs are $850,000 per year. The tax rate is 35 percent, and we require a 15 percent return on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within

Explanation / Answer

CF0 = -724,000 EBIT = 90,000 [ $43 - $29 ] - $780,000 EBIT = 90,000 [ $14 ] - $780,000 EBIT = $1,260,000 - $780,000 EBIT = $480,000 After Tax FCF = $480,000 (1 - 35%) After Tax FCF = $480,000 (65%) After Tax FCF = $480,000 (0.65) After Tax FCF = $312,000 Free Cash Flows CF0 = -724,000 CF1 - CF8 = $312,000 WACC = 15% NPV = $-724,000 + [$312,000] PVIFA[15%,8] PVIFA[15%,8] = [1 - (1+15%)^-8]/15% PVIFA[15%,8] = [1 - (1.15)^-8]/0.15 PVIFA[15%,8] = [1 - 0.3269]/0.15 PVIFA[15%,8] = [0.6731]/0.15 PVIFA[15%,8] = 4.487322 NPV = $-724,000 + [$312,000] x 4.487322 NPV = $-724,000 + $1,400,044 NPV = $676,044

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