Hope Corporation is considering an expansion project. The proposed project has t
ID: 2750193 • Letter: H
Question
Hope Corporation is considering an expansion project. The proposed project has the following features: (17 points)
The project has an initial cost of $1,000,000 (machine: $800,000, insurance: $40,000, shipping $60,000, modification: $100,000) --this is also the amount which can be depreciated using the following 5 year MACRS depreciation schedule:
Year Depreciation Rate
1 20%
2 32
3 19.20
4 11.52
5 11.52
6 5.76
The sales price is expected to increase by 2 percent per year due to inflation.
The variable cost is expected to increase by 3 percent per year.
The fixed cost will be $50,000 per year for the next five years. (No fixed cost increase)
Number of units sold will grow by 5 percent every year.
If the project is undertaken, net working capital would have to increase by an amount equal to 10% of sales revenues. This net operating working capital will be recovered at the end of the project’s life (t = 5). (You must consider an inflation effect.)
If the project is undertaken, the company will sell additional 200,000 units in year one (t = 1). Unit price at the end of the Year 1 is $10.
Unit price is $10 and variable unit cost is $4 at the end of the Year 1.
The company’s tax rate is 30 percent.
The company has no debt.
At the end of Year 5, the project’s economic life is complete, but the company can sell the machine at $20,000 (market value of salvage).
The project’s WACC = 10 percent.
Hint: You can start from CH 11 Tool kit excel spreadsheet.
Calculate NPV using Excel.
Using “Two Way Data Table” of the Excel, show the sensitivity of the NPV of the project to the growth rate of units sold per year (Use the growth rate from 0% to 10% in 1% increment) and to the project’s WACC (Use the WACC 7% to 13% in 1% increment),
Explanation / Answer
Net present value = Present value of cash Inflow - Present value of cash outflow
= 3394857 - 1000000 = 2394857
Present value of cash outflow
Particulars
(at Y= 0) Amount
Cash outflow
1000000
PVF (Y=0)
1
Present value of cash outflow
1000000
Present value of cash Intflow
Particulars
Y=1
Y=2
Y=3
Y=4
Y=5
Sale units
200000
210000
220500
231525
243101
Sale price
10
10.2
10.404
10.612
10.824
Cost
4
4.12
4.2436
4.371
4.502
Contribution per unit
6
6.08
6.1604
6.241
6.322
Contribution (in $)
1200000
1276800
1358368
1444948
1536885
Less fixed cost
50000
50000
50000
50000
50000
EBT and depreciation (a)
1150000
1226800
1308368
1394948
1486885
Less depreciation
200000
256000
104448
50636
44803
EBT
950000
970800
1203920
1344312
1442082
Less: tax (b)
285000
291240
361176.1
403293.5
432624.5
EAT (a-b)
865000
935560
947192.1
991654.1
1054260
Less- working capital increment
-
14200
15208
16286
17438
Sale value Net of tax
117234
Cash inflow
865000
921360
931984
975368
1154055
PVF
.909
.812
.712
.613
.519
PV of cash inflow
786285
748144
663573
597901
598955
Present value of cash Inflow= 3394857
Particulars
(at Y= 0) Amount
Cash outflow
1000000
PVF (Y=0)
1
Present value of cash outflow
1000000
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