ELC Electrical Services is considering the construction of a plant to manufactur
ID: 452219 • Letter: E
Question
ELC Electrical Services is considering the construction of a plant to manufacture a new energy saving device for small offices. The company recently commissioned a $100,000, two-year study to assess the market demand for the proposed product. It estimated that 30,000 units of its new product could be sold annually over the next 10 years at a price of $10,000 each. Subcontractors would install each device at a cost of $6,200 per installation. The project involves an initial outlay of $60 million to build production facilities and $4 million in land. The $60 million facility will be depreciated using the prime cost method over the project’s life (fully depreciated at the end of the project). Fixed costs of $12 million per annum will be incurred. The facilities, including the land will be sold for an estimated value of $15 million at the end of the project. The land value is assumed to stay constant throughout the lifespan of the project. The company is an ongoing profitable business and pays taxes at a 30% rate in the year of income. It uses a 15% per year discount rate on the new project. Using the NPV approach, determine whether the project should be undertaken (use the relevant tax rate in your analysis). Comment
Explanation / Answer
The company recently commissioned a $100,000, two-year study to assess the market demand for the proposed product - Sunk Cost and hence not considered for NPV Analysis
Year 1 2 3 4 5 6 7 8 9 10 # Units a 30000 30000 30000 30000 30000 30000 30000 30000 30000 30000 Revenue per unit b $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 Subcontract Cost per unit c $6,200 $6,200 $6,200 $6,200 $6,200 $6,200 $6,200 $6,200 $6,200 $6,200 Contribution per unit d = b - c $3,800 $3,800 $3,800 $3,800 $3,800 $3,800 $3,800 $3,800 $3,800 $3,800 Total Contribution e = d*a $114,000,000 $114,000,000 $114,000,000 $114,000,000 $114,000,000 $114,000,000 $114,000,000 $114,000,000 $114,000,000 $114,000,000 Fixed Cost f $12,000,000 $12,000,000 $12,000,000 $12,000,000 $12,000,000 $12,000,000 $12,000,000 $12,000,000 $12,000,000 $12,000,000 Depreciation ($60m/10 years) g $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 Earnings before Tax h = e-f-g $96,000,000 $96,000,000 $96,000,000 $96,000,000 $96,000,000 $96,000,000 $96,000,000 $96,000,000 $96,000,000 $96,000,000 Taxes at 30% i $28,800,000 $28,800,000 $28,800,000 $28,800,000 $28,800,000 $28,800,000 $28,800,000 $28,800,000 $28,800,000 $28,800,000 Earnings after Tax k = h - i $67,200,000 $67,200,000 $67,200,000 $67,200,000 $67,200,000 $67,200,000 $67,200,000 $67,200,000 $67,200,000 $67,200,000 Depreciation l $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 Cash flow from operations m = k + l $73,200,000 $73,200,000 $73,200,000 $73,200,000 $73,200,000 $73,200,000 $73,200,000 $73,200,000 $73,200,000 $73,200,000 Post tax salvage Value of Land n $0 $0 $0 $0 $0 $0 $0 $0 $0 $11,700,000 Total Cash Inflow o = m+n $73,200,000 $73,200,000 $73,200,000 $73,200,000 $73,200,000 $73,200,000 $73,200,000 $73,200,000 $73,200,000 $84,900,000 PV Factor at 15% p 0.8696 0.7561 0.6575 0.5718 0.4972 0.4323 0.3759 0.3269 0.2843 0.2472 Present Value at 15% q = p * o $63,652,174 $55,349,716 $48,130,188 $41,852,338 $36,393,337 $31,646,380 $27,518,591 $23,929,210 $20,808,009 $20,985,982 Present Value of Cash Inflow a $370,265,924 Initial Outflow Land and Machinery ($60m + $4m) b $64,000,000 NPV a-b $306,265,924 Expected Sale Value of Land a $15,000,000 Purchase Price b $4,000,000 Profit from Sale c = a-b $11,000,000 Tax on Profit d = c*30% $3,300,000 Post tax Salvage Value e = a-d $11,700,000Related Questions
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