Glop, Inc., is considering a machine which will cost $50,000 at Time 0 and which

Question

Glop, Inc., is considering a machine which will cost $50,000 at Time 0 and which can be sold after 3 years for $10,000. $12,000 must be invested at Time 0 in inventories and receivables (this is part of the initial investment, but there are no tax effects resulting from the cash outflows). These funds (the inventory and receivables investments) will be recovered when the operation is closed at the end of year 3. The facility will produce sales revenues of $50,000/year for 3 years. Variable operating costs (excluding depreciation) will be 40 percent of sales. No fixed costs will be incurred. Operating cash inflows will begin 1 year from today (at t = 1). By an act of Congress, the machine will have depreciation expenses of $40,000, $5,000, and $5,000 in Years 1, 2, and 3 respectively. The company has a 40 percent tax rate, enough taxable income from other assets to enable it to get a rax refund on this project if the project's income is negative, and a 15 percent required rate of return. Inflation is zero. What is the project's NPV?

Explanation / Answer

NPV = present Value of inflow - Present value of outflow

Present value of outflow NPV @ 15% :

intial outflow = $50000

Intial investment in inventories and receivables = $12000

Net present value of cash outflow = $62000

Present value of Cash inflow NPV @15% :

year cash inflow VC Depreciation PBT PAT CF PVF(15% , n) PV

1 50000 20000 40000 -10000 -14000 26000 0.870 22620

2 50000 20000 5000 25000 15000 20000 0.756 15120

3 50000 20000 5000 25000 15000 20000 0.658 13160

3 Salvage value of machine 10000 0.658 6580

3 Investment in inventories and receivables 12000 0.658 7896

Present value of Cash Inflow 65376

Here, VC= variable cost, PBT = profit before tax , PAT = profit after tax , CF =cash flow (Depreciation + PAT)

SO. the NPV = 65376 - 62000

   = $ 3376

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