With the growing popularity of casual surf print clothing, two recent MBA gradua

Question

With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital, they decided to focus on surf print table and floor lamps to accent people’s homes. They projected unit sales of these lamps to be 8,300 in the first year, with growth of 4 percent each year for the following four years (Years 2 through 5). Production of these lamps will require $48,000 in networking capital to start. Total fixed costs are $108,000 per year, variable production costs are $16 per unit, and the units are priced at $44 each. The equipment needed to begin production will cost $188,000. The equipment will be depreciated using the straight-line method over a five-year life and is not expected to have a salvage value. The effective tax rate is 39 percent, and the required rate of return is 25 percent. What is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Explanation / Answer

Calculation of after tax cash flow for 5 years Year 1 2 3 4 5 Sales in units                8,300                         8,632                      8,977               9,336               9,710 Selling price per unit $44 $44 $44 $44 $44 Sales (A) $3,65,200 $3,79,808 $3,95,000 $4,10,800 $4,27,232 Variable cost per unit $16 $16 $16 $16 $16 Variable cost (B) $1,32,800 $1,38,112 $1,43,636 $1,49,382 $1,55,357 Contribution margin (A-B) $2,32,400 $2,41,696 $2,51,364 $2,61,418 $2,71,875 Less : Fixed cost $1,08,000 $1,08,000 $1,08,000 $1,08,000 $1,08,000 Less : Depreciation $37,600 $37,600 $37,600 $37,600 $37,600 Profit before tax $86,800 $96,096 $1,05,764 $1,15,818 $1,26,275 Less : Tax @ 39% $33,852 $37,477 $41,248 $45,169 $49,247 Profit after tax $52,948 $58,619 $64,516 $70,649 $77,028 (+) Depreciation $37,600 $37,600 $37,600 $37,600 $37,600 After tax cash flow $90,548 $96,219 $1,02,116 $1,08,249 $1,14,628 Depreciation using straight line method = $188000 / 5 years = $37600 per year Initial outlay for the project Working capital required $48,000 Equipment $1,88,000 Total Initial outlay $2,36,000 Calculation of NPV of the project at required rate of return of 25% Year Cash flow PV factor at 25% Present value 0 -$2,36,000 1 -$2,36,000.00 1 $90,548 0.8 $72,438.40 2 $96,219 0.64 $61,580.16 3 $1,02,116 0.512 $52,283.39 4 $1,08,249 0.4096 $44,338.79 5 $1,14,628 0.32768 $37,561.30 Net Present value $32,202.05

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