A project requires an initial fixed asset investment of $600,000, which will be
ID: 2766671 • Letter: A
Question
A project requires an initial fixed asset investment of $600,000, which will be depreciated straight-line to zero over the 6-year life of the project. The pretax salvage value of the fixed assets at the end of the project is estimated to be $50,000. Projected sales volume for each year of the project is shown below. The sale price is $50 per unit. A $30,000 initial investment in net working capital is required, and is recovered at the end of the project. Variable costs are $35 per unit, and fixed costs are $50,000 per year. The firm has a tax rate of 34%, and a required return on investment of 12%.
Year
1
2
3
4
5
6
Sales
10,000
11,000
12,000
13,000
14,000
15,000
Estimate relevant cash flow of the project.
What is NPV of the project?
Should the project be accepted?
Year
1
2
3
4
5
6
Sales
10,000
11,000
12,000
13,000
14,000
15,000
Explanation / Answer
ntribution per unit = Sales - Variable cost = $50 - $35 = $15
Contribution in table above is calculated multiplying Contribution per unit with unit sales
Relevant cash flows as in the table above are Cash Flows after tax. Depreciation is a non cash expense but is relevant only for the purpose of tax savings.
NPV of the project is -$159535.03
Since NPV is less than zero project should not be accepted.
Year Initial Cost Contribution Salvage Value + WC recovered Depreciation Fixed Cost Net Cash Flows Before Tax Tax Cash Flows After Tax PV Factor @ 12% PV 0 -630000 -630000 1 -630000 1 150000 100000 50000 0 0 100000 0.8929 89285.71 2 165000 100000 50000 15000 5100 105100 0.7972 83785.08 3 180000 100000 50000 30000 10200 110200 0.7118 78438.18 4 195000 100000 50000 45000 15300 115300 0.6355 73275.23 5 210000 100000 50000 60000 20400 120400 0.5674 68318.19 6 225000 80000 100000 50000 125000 52700 152700 0.5066 77362.57 Net Present Value -159535.03Related Questions
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