Aria Acoustics, Inc., (AAI) projects unit sales for a new seven-octave voice emu

Question

Aria Acoustics, Inc., (AAI) projects unit sales for a new seven-octave voice emulation implant as follows: Year Unit Sales 1 110,000 2 129,000 3 117,000 4 100,000 5 86,000 Production of the implants will require $1,540,000 in net working capital to start and additional net working capital investments each year equal to 15 percent of the projected sales increase for the following year. Total fixed costs are $1,390,000 per year, variable production costs are $229 per unit, and the units are priced at $349 each. The equipment needed to begin production has an installed cost of $25,000,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS (MACRS Table) property. In five years, this equipment can be sold for about 20 percent of its acquisition cost. AAI is in the 35 percent marginal tax bracket and has a required return on all its projects of 18 percent. What is the NPV of the project?

Explanation / Answer

Here, Depreciation = Investment x MACRS (%)

Cash Flows = Investment + NWC + Salvage Value + Net Income + Depreciation

NPV can be calculated using NPV function on a calculator or excel

AAI 0 1 2 3 4 5 MACRS 14.29% 24.49% 17.49% 12.49% 8.93% Unit Sales 110000 129000 117000 100000 86000 Investment -$    25,000,000 NWC -$      1,540,000 -$     994,650 $      628,200 $      889,950 $      732,900 $      283,600 Salvage $   5,000,000 Sales $ 38,390,000 $ 45,021,000 $ 40,833,000 $ 34,900,000 $ 30,014,000 VC -$25,190,000 -$29,541,000 -$26,793,000 -$22,900,000 -$19,694,000 FC -$ 1,390,000 -$ 1,390,000 -$ 1,390,000 -$ 1,390,000 -$ 1,390,000 Depreciation -$ 3,572,500 -$ 6,122,500 -$ 4,372,500 -$ 3,122,500 -$ 2,232,500 EBT $   8,237,500 $   7,967,500 $   8,277,500 $   7,487,500 $   6,697,500 Taxes (35%) -$ 2,883,125 -$ 2,788,625 -$ 2,897,125 -$ 2,620,625 -$ 2,344,125 Net Income $   5,354,375 $   5,178,875 $   5,380,375 $   4,866,875 $   4,353,375 Cash Flows -$    26,540,000 $   7,932,225 $ 11,929,575 $ 10,642,825 $   8,722,275 $ 11,869,475 NPV $ 4,914,520.79 IRR 25.62%

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