XYZZ Corporation is considering an expansion project. The proposed project has t
ID: 2762033 • Letter: X
Question
XYZZ Corporation is considering an expansion project. The proposed project has the following features:
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 3 year MACRS depreciation schedule:
Year Depreciation Rate
1 33%
2 45%
3 15%
4 7%
The sales price and cost are both expected to increase by 4 percent per year due to inflation.
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 = 4). (You must consider an inflation effect.)
If the project is undertaken, the company will sell additional 100,000 units in the next three years (t = 1, 2, 3, 4),
Unit price at the end of the Year 1 is $10.
The company’s operating cost (not including depreciation) will equal to 50% of sales.
The company’s tax rate is 40 percent.
The company has no debt.
At the end of Year 4, 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 = 8 percent.
What is the project’s net present value (NPV)?
Explanation / Answer
Where sales –opex = price*units sold*opex cost as a percentage of sales*(1+inflation rate)
Net salvage value = salvage price*(1-tax rate)
NWC = 10% of sales –opex for year 1
NWC for remaining years = 10% of sales –opex-cumulative of previous NWC
Time line 0 1 2 3 4 sales-opex 500000 520000 540800 562432 MACR rate 20% 32% 19.20% 11.52% -Depreciation MACR Rate* total investment -200000 -320000 -192000 -115200 = 300000 200000 348800 447232 -taxes =(savings- depreciation)*(1-tax) 180000 120000 209280 268339.2 +Depreciation 200000 320000 192000 115200 =after tax operating cash flow 380000 440000 401280 383539.2 Capital spending Cost of equipment -1000000 Installation cost 0 Total investment in new machine -1000000 (NWC) -50000 -2000 -2080 -2163.2 Reversal of NWC 56243.2 Net salvage value 12000 Capital spending CF= -1000000 -50000 -2000 -2080 66080 Total Cash flow= Operating CF + Capital spending CF= -1000000 330000 438000 399200 449619.2 Discount factor =(1+discount rate)^n 1 1.08 1.1664 1.259712 1.360489 Discount rate= 8% Discounted cash flows -1000000 305555.6 375514.4 316897.8 330483.5 NPV= Sum of discounted cash flows 328451.3Related Questions
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