Company X is analyzing a new investment project which has the following characte
ID: 2788355 • Letter: C
Question
Company X is analyzing a new investment project which has the following characteristics:
Unit price $5.00
Annual unit sales 40,000
Variable cost per unit $2.25
Investment into new machinery (t=0) $300,000
Investment in working capital $50,000 (fully recovered at the end of project)
Project life 6 years
Annual depreciation $40,000
Market value of machinery (t=6) 30,000
Tax rate 40 % (the same for profits and capital gains)
Required rate of return (WACC) 10 %
Marketing research expense $11,000 (the research was conducted earlier this year)
Questions:
Calculations in excel (show formulas ) , or manually
a ) Calculate project cash flows: initial investment, operating cash flows for each year and terminal cash flow
b) Evaluate the net present value for the project
c) Is the project good as an investment?
Explanation / Answer
We wont consider the cost of marketing research into the calculation of NPV and thus the $11,000 cost isnt considered.
Answer a.
The inital investment outlay = FCinv + Wcinv
=300,000 + 50,000
=350,000
Thus initial investment is -350,000
Operating cashflow for each year ie. After tax operating cashflow = (sales-cost-depreciation)*(1-tax)+Depreciation
sales = annual unit sales * unit cost = 40,000*5 = 200,000
Cost = annual unit sales * Variable cost per unit = 40,000*2.25 = 90,000
and depreciation = 40,000 and tax is 40%
Thus,
ATOCF = (sales-cost-depreciation)*(1-tax)+Depreciation
=(200,000-90,000-40000)*(1-0.4)+40000
=70000(0.6)+40000
=42000+40000
=82,000
Terminal cash flow = Salvage + WCinv - Tax*(Salvage-Book value)
Depreciation is 40000 per annum for 6 years thus total depreciation is 40000*6=240000
Thus the book value after t=6 is 300,000-240,000=60,000
Thus,
Terminal cash flow = Salvage + WCinv - Tax*(Salvage-Book value)
=30,000 + 50,000 - 0.4*(30,000-60,000)
=80,000 - 0.4(-30,000)
=80,000 - (-12000)
=92,000
(and this is added to final year ATOCF)
Answer b.
The NPV for the project is as below:
Year
ATOCF
0
-350000
1
82000
2
82000
3
82000
4
82000
5
82000
6
174000
NPV at WACC of 10%
53693.617
Answer c.
Yes as the NPV os the project is positive at 53693.617, we accept the project and it is good investment
Year
ATOCF
0
-350000
1
82000
2
82000
3
82000
4
82000
5
82000
6
174000
NPV at WACC of 10%
53693.617
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