Bender Guitar Corporation, a manufacturer of custom electric guitars, is contemp
ID: 2701872 • Letter: B
Question
Bender Guitar Corporation, a manufacturer of custom electric guitars, is contemplating a $1,000,000 investment in a new production facility. The economic life of the facility is estimated to be five years, after which the facility will be obsolete and have no salvage value.
To make the new facility operational, building improvements costing $400,000 will be required. In addition, a $50,000 increase in working capital will be needed.
Bender's accounting and marketing departments have provided the following information: the firm will use the straight-line method of depreciation; the Company is in the 30% tax bracket; the weighted average cost of capital is 8%.
Here are Earnings before Interest and Taxes (EBIT) estimates for the new facility:
Year 1.........$80,000
Year 2.......$100,000
Year 3.......$120,000
Year 4........$140,000
Year 5.......$165,000
Explanation / Answer
Year 1 2 3 4 5 Outflow in investment in first year (1,000,000.00) Outflow in building improvement (400,000.00) Outflow in Working capital (50,000.00) Release in working capital at the end ( c) 50000 Present value of discounting factor @ 8% (b) 0.681 Present value of release in working capital (b*c) 34,050.00 EBIT 80,000.00 100,000.00 120,000.00 140,000.00 165,000.00 Less: tax @ 30% 24,000.00 30,000.00 36,000.00 42,000.00 49,500.00 Profit after tax 56,000.00 70,000.00 84,000.00 98,000.00 115,500.00 Add: depreciation 200,000.00 200,000.00 200,000.00 200,000.00 200,000.00 Operating cash flow (a) 256,000.00 270,000.00 284,000.00 298,000.00 315,500.00 Present value of discounting factor @ 8% (b) 0.926 0.857 0.794 0.735 0.681 Therefore Present value of Operating cash flow (a*b) 237,056.00 231,390.00 225,496.00 219,030.00 214,855.50 Total discounted Ocf 1,127,827.50 Add: Pv of release in working capital 34,050.00 Total present value of inflow 1,161,877.50 Less: Outflow (1,450,000.00) Net Present value (288,122.50)
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.