ELC Electrical Services is considering the construction of a plant to manufactur

Question

ELC Electrical Services is considering the construction of a plant to manufacture a new energy saving device for small offices. The company recently commissioned a $100,000, two-year study to assess the market demand for the proposed product. It estimated that 30,000 units of its new product could be sold annually over the next 10 years at a price of $10,000 each. Subcontractors would install each device at a cost of $6,200 per installation. The project involves an initial outlay of $60 million to build production facilities and $4 million in land. The $60 million facility will be depreciated using the prime cost method over the project’s life (fully depreciated at the end of the project). Fixed costs of $12 million per annum will be incurred. The facilities, including the land will be sold for an estimated value of $15 million at the end of the project. The land value is assumed to stay constant throughout the lifespan of the project. The company is an ongoing profitable business and pays taxes at a 30% rate in the year of income. It uses a 15% per year discount rate on the new project. Using the NPV approach, determine whether the project should be undertaken (use the relevant tax rate in your analysis).

Explanation / Answer

Solution:

To Compute the cash flow in the initial step :

To compute the NPV of the project :

Since the NPV is positive therefore the project should be selected

1 2 3 4 5 6 7 8 9 10 Particulars/Formula NEw steamer cash flow Unit sold 30000 30000 30000 30000 30000 30000 30000 30000 30000 30000 Total sales (unit sold*price) 300000000 300000000 300000000 300000000 300000000 300000000 300000000 300000000 300000000 300000000 Variable cost(300* units) 186000000 186000000 186000000 186000000 186000000 186000000 186000000 186000000 186000000 186000000 Gross profit 114000000 114000000 114000000 114000000 114000000 114000000 114000000 114000000 114000000 114000000 Depreciation 60000000/10 6000000 6000000 6000000 6000000 6000000 6000000 6000000 6000000 6000000 6000000 Fixed cost 12000000 12000000 12000000 12000000 12000000 12000000 12000000 12000000 12000000 12000000 Profit 96000000 96000000 96000000 96000000 96000000 96000000 96000000 96000000 96000000 96000000 Tax 30% 28800000 28800000 28800000 28800000 28800000 28800000 28800000 28800000 28800000 28800000 Profit after tax 67200000 67200000 67200000 67200000 67200000 67200000 67200000 67200000 67200000 67200000 CAsh flows = profit+depreciation 73200000 73200000 73200000 73200000 73200000 73200000 73200000 73200000 73200000 73200000

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