A business opportunity has presented itself to you and one of your classmates. Y

Question

A business opportunity has presented itself to you and one of your classmates. Your opportunity is to enter the fast growing craft beer industry. Your projected sales in the first year is 8300 kegs. Your projected growth rate is 5 percent. Entering the business will require $35,000 of net working capital. Total fixed costs are $95,000. Variable production costs are $36 per keg and keg sales are priced at $57 each. The equipment to begin production is $175,000. The equipment will be depreciated using straight line depreciation over a five year life and has no salvage value. The tax rate is 35 percent and the required return is 25 percent. What is the NPV of the project and should you pursue the project?

A.- $2,082.17 No, do not take the project.

B. $17,422.51 Yes, take the project.

C. -$35,025.85 No, do not take the project.

Answer should be in these 3 choices. And Please show me how to get the number.

Explanation / Answer

Initial Invetsment = Equipment Cost + Net Working Capital = 175000 + 35000 = $210000

Contribution Margin = (Sale Price - Variable Cost) * Projected Kegs

For example, for year 1, Contribution Margin = (57 - 36) * 8300 = $174300

Depreciation = 175000/3 = $35000

Cash Flow = (Contribution Margin - Fixed Cost) * (1 - Tax Rate) + Tax Rate * Depreciation

For example, for year 1, Cash Flow = (174300 - 95000) * (1 - 35%) + 35% * 35000 = $63795

Similarly Cash flows for all other years can be calculated.

Also, at the end of year 5, working capital is recovered resukting in an increase in cash flow be $35000.

NPV of the project is the sum of dicounted cash flows = -$2082.17

Since NPV of the project is negative, the project should not be taken/pursued.

A.- $2,082.17 No, do not take the project.

Year Equipment Cost Net Working Capital Projected Kegs Sale Price Vairable Cost Contribution Margin Fixed Cost Depreciation Cash Flow Discounted Cash Flow 0 175000 35000.00 -210000.00 -210000.00 1 8300.00 57 36 174300.00 95000.00 35000.00 63795.00 51036.00 2 8715.00 57 36 183015.00 95000.00 35000.00 69459.75 44454.24 3 9150.75 57 36 192165.75 95000.00 35000.00 75407.74 38608.76 4 9608.29 57 36 201774.04 95000.00 35000.00 81653.12 33445.12 5 -35000.00 10088.70 57 36 211862.74 95000.00 35000.00 123210.78 40373.71 NPV -2082.17

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