You are thinking of building a new bakery to bake moon cakes. New bakery will be

Question

You are thinking of building a new bakery to bake moon cakes. New bakery will be built over two years. Today is 12/31/2014. The bakery will be ready to start production on 01/01/2017 and the first revenues and costs will be received and paid on 12/31/2017. The plant will cease production on 12/31/2019. Investment for bakery requires an outlay of $12 million on 12/31/2014. This investment can be fully depreciated on a straight-line basis over the three years the bakery is producing. These machines have no salvage value at the end of three years.

The bakery will produce 2.4 million moon cakes per year. In 2017, the bakery expects to sell the moon cakes for $20 per cake. The raw material costs are expected to be $4 per cake. Total labor costs will $3 m per year. The company expects to keep the production constant, but expects the selling prices, raw material costs, and labor costs to increase in 2018 and 2019 at the rate of inflation, which is expected to be 4% in the long run.

Total working capital requirement on 12/31/2016 to allow investment to be financed is $1,800,000. For the next year the working capital would be 10% higher. Thereafter working capital will remain constant until the end of project’s life. When the plant ceases production, all the working capital can be recovered. Corporate tax rate is 34%. Assume all cash flows occur at the end of the year and the firm has other profitable operations. The company uses a 10% cost of capital for such projects.

What is the NPV of this project? PLEASE SELECT ANSWER AND EXPLAIN WHY

Explanation / Answer

Details                   2,017               2,018                  2,019 Expected production units          2,400,000       2,400,000         2,400,000 Units Selling price                   20.00               20.80                  21.63 Unit RM cost                       4.00                  4.16                    4.33 Labor cost yearly          3,000,000       3,120,000         3,244,800 NPV Calculation Details Year 2014. Year 2015 Year 2016 Year 2017 Year 2018 Year 2019 Investment      (12,000,000) Net working Capital         (1,800,000)         (180,000)            1,980,000 Revenue from sales        48,000,000          49,920,000          51,916,800 Less RM Cost      (9,600,000)          (9,984,000)        (10,383,360) Less Labor cost      (3,000,000)          (3,120,000)          (3,244,800) Less Depreciation      (4,000,000)          (4,000,000)          (4,000,000) Taxable income      31,400,000          32,816,000          34,288,640 Tax @34% (10,676,000)        (11,157,440)        (11,658,138) Post Tax income        20,724,000          21,658,560          22,630,502 Add back depreciation        4,000,000            4,000,000            4,000,000 Net Cash flow (with NWC)      (12,000,000)                      -         (1,800,000)      24,544,000          25,658,560          28,610,502 PV factor @10%                           1               0.909                  0.826                0.751                     0.683                     0.621 PV of Cash flows      (12,000,000)                      -         (1,487,603)      18,440,270          17,525,142          17,764,871 NPV =        40,242,680 NPV =$40.24 Million So correct option is E

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.