You are evaluating a project for The Ultimate recreational tennis racket, guaran
ID: 2709677 • Letter: Y
Question
You are evaluating a project for The Ultimate recreational tennis racket, guaranteed to correct that wimpy backhand. You estimate the sales price of The Ultimate to be $400 and sales volume to be 1,000 units in year 1, 1,250 units in year 2, and 1,325 units in year 3. The project has a 3 year life. Variable costs amount to $225 per unit and fixed costs are $100,000 per year. The project requires an initial investment in equipment of $165,000 which is depreciated straight-line to zero over the 3 year project life. The actual market value of the equipment at the end of year 3 is $35,000. Initial (t=0) net working capital (NWC) investment is $80,000 and NWC will maintain a level equal to 20% of the next year’s sales each year thereafter. The tax rate is 35% and the required return on the project is 10%. What is the NPV of this project?
Explanation / Answer
Year
0
1
2
3
Sales Volume (units)
$0.00
$1,000.00
$1,250.00
$1,325.00
Sales price per unit
$0.00
$400.00
$400.00
$400.00
Sales
$0.00
$400,000.00
$500,000.00
$530,000.00
Variable costs ($225 per unit)
$0.00
($225,000.00 )
($281,250.00 )
($298,125.00 )
Fixed costs
$0.00
($100,000.00 )
($100,000.00 )
($100,000.00 )
Depreciation
$0.00
($27,505.50 )
($54,994.50 )
($54,994.50 )
Earning before Interest and taxes (EBIT)
$0.00
$47,494.50
$63,755.50
$76,880.50
Taxes at 34%
$0.00
($16,148.13 )
($21,676.87 )
($26,139.37 )
Income after taxes
$0.00
$31,346.37
$42,078.63
$50,741.13
Depreciation added back
$0.00
$27,505.50
$54,994.50
$54,994.50
Operating Cash Inflows
$0.00
$58,851.87
$97,073.13
$105,735.63
Initial Investments
($165,000.00 )
$32,451.87
Change in Net working capital
($80,000.00 )
($20,000.00 )
($6,000.00 )
$106,000.00
Net cash Inflow/(outflow)
($245,000.00 )
$38,851.87
$91,073.13
$244,187.50
Required rate of return
10%
Post tax rate of return
10% (1-0.34)
6.60%
Discounting factor
1
0.9381
0.8800
0.8255
Present value of cash flows
($245,000.00 )
$36,446.94
$80,144.35
$201,576.78
Net present value = -$245,000 + $36,446.94 + $80,144.35 + $201,576.78 = $73,168.07
Year
0
1
2
3
Sales Volume (units)
$0.00
$1,000.00
$1,250.00
$1,325.00
Sales price per unit
$0.00
$400.00
$400.00
$400.00
Sales
$0.00
$400,000.00
$500,000.00
$530,000.00
Variable costs ($225 per unit)
$0.00
($225,000.00 )
($281,250.00 )
($298,125.00 )
Fixed costs
$0.00
($100,000.00 )
($100,000.00 )
($100,000.00 )
Depreciation
$0.00
($27,505.50 )
($54,994.50 )
($54,994.50 )
Earning before Interest and taxes (EBIT)
$0.00
$47,494.50
$63,755.50
$76,880.50
Taxes at 34%
$0.00
($16,148.13 )
($21,676.87 )
($26,139.37 )
Income after taxes
$0.00
$31,346.37
$42,078.63
$50,741.13
Depreciation added back
$0.00
$27,505.50
$54,994.50
$54,994.50
Operating Cash Inflows
$0.00
$58,851.87
$97,073.13
$105,735.63
Initial Investments
($165,000.00 )
$32,451.87
Change in Net working capital
($80,000.00 )
($20,000.00 )
($6,000.00 )
$106,000.00
Net cash Inflow/(outflow)
($245,000.00 )
$38,851.87
$91,073.13
$244,187.50
Required rate of return
10%
Post tax rate of return
10% (1-0.34)
6.60%
Discounting factor
1
0.9381
0.8800
0.8255
Present value of cash flows
($245,000.00 )
$36,446.94
$80,144.35
$201,576.78
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