We are evaluating a project that costs $829,000, has an nine-year life, and has
ID: 2711665 • Letter: W
Question
We are evaluating a project that costs $829,000, has an nine-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 113,000 units per year. Price per unit is $37, variable cost per unit is $21, and fixed costs are $845,580 per year. The tax rate is 37 percent, and we require a 20 percent return on this project. The projections given for price, quantity, variable costs, and fixed costs are all accurate to within +/- 13 percent.
Required:
(a) Calculate the best-case NPV. (Do not round your intermediate calculations.)
(b) Calculate the worst-case NPV. (Do not round your intermediate calculations.)
Explanation / Answer
COST OF PROJECT=$8,29,000
LIFE=9 YEARS
DEPRECIATION=$8,29,000/9=$92,111
SALES UNITS=1,13,000 UNITS PER YEAR
PRICE PER UNIT=$37
VARIABLE COST PER UNIT=$21
CALCULATION OF NET CASH INFLOW
SALES=1,13,000*$37 =$41,81,000
LESS:VARIABLE COST=1,13,000*$21=$23,73,000
LESS:FIXED COST =$8,45,580
$9,62,420
LESS:DEPRECIATION =$ 92,111
TAXABLE INCOME =$ 8,70,309
TAX RATE=37% =$ 3,22,014
INCOME AFTER TAX =$ 5,48,295
ADD:DEPRECIATION =$ 92,111
NET CASH INFLOW =$ 6,40,406
RATE OF RETURN=20%
AFTER TAX RATE OF RETURN=20%-37%=12.6%
PRESENT VALUE FACTOR @12.6% FOR 9 YEARS=5.209
PRESENT VALUE OF NET CASH INFLOW=$6,40,406*5.209=$33,35,875
NPV=PRESENT VALUE OF NET CASH INFLOW-INITIAL COST
=$33,35,875-$8,29,000
=$25,06,875
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