6. (30 points) Over a five (5) year period, your firm will operate a new product

Question

6. (30 points) Over a five (5) year period, your firm will operate a new production line. It will take out a loan to finance the equipment purchase and set-up. The purchase price and loan amount are shown below. The loan is over the five-year lifetime with annual payments. The marginal tax rate is 35%. The annual operating profit in 12/31/2010 ( 0) dollars is $400,000 (revenue-operating expenses) over the lifetime. This operating profit is indexed to an inflation rate shown in the total mfg producer price index (see table in back). The equipment is depreciated using the straight-line method. The firm keeps a constant inflationary MARR of 15%. Actual dollar figures in table below. The years below refer to end of year (i.e., 2011 is 12/31/2011). Int Princ Dep Taxable Tax Net Op L AssetProfit Proc Profit ATCF A/T Inc Repay 0 0 500K 2010 -750K 20110 408,462 0 -50K -100K -150K 208,462-72,962 135,500 2012 2013 2014 2015 0 0 0 0 -250K 0 0 0 0 -40K -100K -150K 220,132-77,046 143,086 0-30K 100K -150K 233,47 0 -20K100K150K 222,503-77,876144,627 o -10K -100K -150K 224,858 -78,700 146,158 2-81,715 151,757 a. What is the non-inflationary MARR in 2011? (Hint: just consider 2011 inflation.) b. What is the NPV of the 2011 ATCF? c. What is the cumulative inflation over the project lifetime? (Hint: the price index table in back can be used here.)

Explanation / Answer

a) Inflator in 2011 = total mfg price index 2011 / total mgf price index 2010 = 1.1006/1.0778 = 1.0211
Hence, non-inflationary MARR 2011 = 15%/1.0211 = 14.69%

b) CF 2011 = Op profit - Int Cost -Princpal Repayment - Tax = 408462 - 50000-100000-72962 = 185500
NPV = CF 2011/Inflator 2011 = 185500/1.0211 (calculated in part a) = 18166.83

c) Cumulartive inflation in %= [(Index 2015/Index 2010)-1]*100 = [1.037/1.0778-1]*100= [0.9621 - 1]*100 = -3.78%

d) t =0 value of depreciation in 2015 = decpreciation in 2015/(1+cumulative inflation in 2015) = 150,000/(1-0.0378) = 155892.7

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