The great eastern toy company management is considering an investment in a new p

Question

The great eastern toy company management is considering an investment in a new product. It would require the acquisition of a piece of equipment for $16 million with a 10 year operational life, providing regular maintenance is carried out. Salvage value of the equipment is estimated at $800,000. The product's economic life is expected to be five years, with annual revenues estimated at $10.8 million during this period. Raw material for the new product is estimated at $95 per unit produced, and an inventory equivalent to one month's production, or 3000 units, would be needed. Direct cost of manufacture are expected to be $130,000 per month. Work-in-progress and finished goods inventories would rise by $150,000. For tax purposes, fixed assets must be depreciated according to the straight-line method. The corporate income tax rate is 40% and so is the capital-gain tax rate. The company's cost of capital is 12%.
A. Based on the above data, set out the cash flows expected from the project. B. What is the net present value of the project? The great eastern toy company management is considering an investment in a new product. It would require the acquisition of a piece of equipment for $16 million with a 10 year operational life, providing regular maintenance is carried out. Salvage value of the equipment is estimated at $800,000. The product's economic life is expected to be five years, with annual revenues estimated at $10.8 million during this period. Raw material for the new product is estimated at $95 per unit produced, and an inventory equivalent to one month's production, or 3000 units, would be needed. Direct cost of manufacture are expected to be $130,000 per month. Work-in-progress and finished goods inventories would rise by $150,000. For tax purposes, fixed assets must be depreciated according to the straight-line method. The corporate income tax rate is 40% and so is the capital-gain tax rate. The company's cost of capital is 12%.
A. Based on the above data, set out the cash flows expected from the project. B. What is the net present value of the project? The great eastern toy company management is considering an investment in a new product. It would require the acquisition of a piece of equipment for $16 million with a 10 year operational life, providing regular maintenance is carried out. Salvage value of the equipment is estimated at $800,000. The product's economic life is expected to be five years, with annual revenues estimated at $10.8 million during this period. Raw material for the new product is estimated at $95 per unit produced, and an inventory equivalent to one month's production, or 3000 units, would be needed. Direct cost of manufacture are expected to be $130,000 per month. Work-in-progress and finished goods inventories would rise by $150,000. For tax purposes, fixed assets must be depreciated according to the straight-line method. The corporate income tax rate is 40% and so is the capital-gain tax rate. The company's cost of capital is 12%.
A. Based on the above data, set out the cash flows expected from the project. B. What is the net present value of the project?

Explanation / Answer

a. The cash flows are as shown below:

b. The NPV of the project is calculated as follows:

NPV = -4,544,281.55 (Negativfe). The project is unprofitable

Year 0 1 2 3 4 5 Intial Cost -16000000 Revenues 10800000 10800000 10800000 10800000 10800000 Raw material cost -3420000 -3420000 -3420000 -3420000 -3420000 Direct Cost -1560000 -1560000 -1560000 -1560000 -1560000 Inventories -1800000 -1800000 -1800000 -1800000 -1800000 Depreciation -1600000 -1600000 -1600000 -1600000 -1600000 Profit before tax 2420000 2420000 2420000 2420000 2420000 Tax at 40% -968000 -968000 -968000 -968000 -968000 Net Income 1452000 1452000 1452000 1452000 1452000 Add back dpereciation 1600000 1600000 1600000 1600000 1600000 Salavage value 800000 Cash flow -16,000,000.00 3,052,000.00 3,052,000.00 3,052,000.00 3,052,000.00 3,852,000.00

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