Your mother really dislikes the low quality of T-shirts that your company makes.
ID: 2761288 • Letter: Y
Question
Your mother really dislikes the low quality of T-shirts that your company makes. She also dislikes the low-brow sayings and tasteless pictures that you print on them - she won’t let your younger sister wear them. Thus, your mom has been pestering you to expand and produce a higher quality line of T-shirts in addition to your current selection. Below are the details on this project. Cost of new equipment: $80,000 Installation cost of equipment: $40,000 Life of equipment: 5 years, Straight line depreciation Expected sales: $170,000 per year Expected reduction in sales of cheap T-shirts as your few sober customers will probably shift to the new line: $10,000 per year Raw material cost: $90,000 per year New worker salary: $20,000 per year Required Net working capital over the life of the project: $20,000 Expected Salvage value of equipment at the end of 5 year: $30,000 Tax rate: 35%. Assuming a WACC of 15%, what is this project’s NPV?
Explanation / Answer
Year 0 1 2 3 4 5 Expected Sales a $170,000.00 $170,000.00 $170,000.00 $170,000.00 $170,000.00 Reduction in Cheaper Product Sales b $10,000.00 $10,000.00 $10,000.00 $10,000.00 $10,000.00 Raw Material Cost c $90,000.00 $90,000.00 $90,000.00 $90,000.00 $90,000.00 New Worker Salary d $20,000.00 $20,000.00 $20,000.00 $20,000.00 $20,000.00 Depreciation (Note 1) e $18,000.00 $18,000.00 $18,000.00 $18,000.00 $18,000.00 Net Increse in Income f = a-b-c-d-e $32,000.00 $32,000.00 $32,000.00 $32,000.00 $32,000.00 Taxes at 35% g = f*35% $11,200.00 $11,200.00 $11,200.00 $11,200.00 $11,200.00 Profit after tax h = f-g $20,800.00 $20,800.00 $20,800.00 $20,800.00 $20,800.00 Depreciation i $18,000.00 $18,000.00 $18,000.00 $18,000.00 $18,000.00 Cash from from operations j = h+i $38,800.00 $38,800.00 $38,800.00 $38,800.00 $38,800.00 Cost of Machine (Note 1) k -$120,000.00 $0.00 $0.00 $0.00 $0.00 $0.00 Working Capital l -$20,000.00 $0.00 $0.00 $0.00 $0.00 $20,000.00 Post tax salvage value of machinery m $0.00 $0.00 $0.00 $0.00 $30,000.00 Total Cashflow from Project n = j+k+l+m -$140,000.00 $38,800.00 $38,800.00 $38,800.00 $38,800.00 $88,800.00 PV Factor at 15% o 1.0000 0.8696 0.7561 0.6575 0.5718 0.4972 Present Value at 15% p = n*o -$140,000.00 $33,739.13 $29,338.37 $25,511.63 $22,184.03 $44,149.29 Net Present Value = $ 14,922.45 Note 1 Cost of Equipment (a) $80,000.00 Installation Cost (b) $40,000.00 Cost of Machine (c = a+b) $120,000.00 Less: Salvage Value $30,000.00 Depreciable Value (d) $90,000.00 Years of Operation ( e) 5 Depreciation per year $18,000.00 Salvage Value $30,000.00 Book Value ($120000 - $90000) $30,000.00 Profit $0.00 Post tax cash flow from machine $30,000.00 Since Tax = 0, Salvage Value equals cash from from machine after project term
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