Dumba is considering expanding into a new line of business.The expansion will re

Question

Dumba is considering expanding into a new line of business.The expansion will require an investment today of $500,000 in newequipment. This equipment, which will cost another $300,000 todayto install, will be depreciated on a straight line basis over an 8year period to an estimated salvage value of zero. The expansionproject will require a working capital investment of $100,000today. Revenues for the first 3 years are forecasted at $650,000per year and at $800,000 in years 4-8. Operating costs exclusive ofdepreciation are expected to be $310,000 per year for 3 years andincrease to $400,000 per year for the following 5 years. Dumba hasa tax rate of 40% and its required rate of return for the projectunder consideration is 16%. Dumba assumes that the new equipmentwill have an actual market value of $50,000 at the end of the 8thyear. What is the NPV of the project? Show workings. thanks Dumba is considering expanding into a new line of business.The expansion will require an investment today of $500,000 in newequipment. This equipment, which will cost another $300,000 todayto install, will be depreciated on a straight line basis over an 8year period to an estimated salvage value of zero. The expansionproject will require a working capital investment of $100,000today. Revenues for the first 3 years are forecasted at $650,000per year and at $800,000 in years 4-8. Operating costs exclusive ofdepreciation are expected to be $310,000 per year for 3 years andincrease to $400,000 per year for the following 5 years. Dumba hasa tax rate of 40% and its required rate of return for the projectunder consideration is 16%. Dumba assumes that the new equipmentwill have an actual market value of $50,000 at the end of the 8thyear. What is the NPV of the project? Show workings. thanks

Explanation / Answer

                     0      1     2      3     4      5     6      7     8 Equipment            -500                                                   50 Installation         -300 Investment in WC      -100 Revenue                     650    650    650   800    800    800   800    800 Operatingcosts             -310   -310   -310   -400  -400   -400   -400   -400 Profits                     340    340    340   400    400    400   400    400 Depreciation                -62.5 -62.5 -62.5 -62.5 -62.5 -62.5 -62.5 -62.5 Taxable amount       -900   277.5 277.5 277.5 337.5 337.5 337.5 337.5 387.5 After tax amount      -540  166.5 166.5 166.5 202.5 202.5 202.5 202.5 232.5 All amounts are listed in thousands. This approach assumes thatinstallation costs are not depreciated and that only the 500k isdepreciated. The NPV of the after tax amount is 268k.

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