Weston Clothing Company is considering manufacturing a new style of shirt, whose

Question

Weston Clothing Company is considering manufacturing a new style of shirt, whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. However, this project would compete with other Weston's products and would reduce their pre-tax annual cash flows. What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.)

WACC 10.0%

Pre-tax cash flow reduction for other products (cannibalization) $5,000

Investment cost (depreciable basis) $80,000

Straight-line deprec. rate 33.333%

Sales revenues, each year for 3 years $67,500

Annual operating costs (excl. deprec.) $25,000

Tax rate 35.0%

PLEASE SHOW WORK!!!

Explanation / Answer

Depreciation per year = 80000/3 = 26,666.67

Income before tax = sales - operating cost - depreciation = 67500-25000-26666.67 = 15,833.33

Net income = 15,833.33*(1-35%) = 10,291.67

Cashflow from operations in year 1-3 = 10,291.67 + depreciation = 10,291.67+26,666.67 = 36,958.33

Post tax impact of cannibalization = 5000*(1-35%) = 3250

So net cashflow in each year = 36,958.33 - 3250 = 33,708.33

NPV = -80000+33,708.33/1.1+33,708.33/1.1^2+33,708.33/1.1^3 = $3827.64

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