Calculating Project
The zither industry will have a rapid expansion in the next four years. With the brand name recognition that PUTZ brings to bear, we feel that the company will be able to sell 3,600, 4,300, 5,200, and 3,900 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $750 can be charged for each zither. Because zithers appear to be a fad, we feel at the end of the four-year period, sales should be discontinued.
PUTZ believes that fixed costs for the project will be $415,000 per y ear, and variable costs are 15 percent of sales. The equipment necessary for production will cost $3.5 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $350,000. Net working capital of $125,000 will be required immediately. PUTZ has a 38 percent tax rate, and the required return on the project is 13 percent. What is the NPV of the project?
To find: The net present value of the project
Introduction:
The variation between the present value of the cash outflows and the present value of the cash inflows are known as the net present value. In capital budgeting the net present value is utilized to analyze the profitability of a project or investment.
Answer to Problem 31QP
The net present value of the project is $1,003,682.32.
Explanation of Solution
Given information:
Person X has been hired for the Company P as a consultant; the company is the manufacturer of fine zithers. The company purchased a land 3 years ago for $2.1 million in anticipation of utilizing it as a toxic waste dump, but in recent times the company has hired another company to take care of the toxic material. Based on the recent appraisal the company assumes that it could sell the land for $2.3 million on the after tax basis.
The company has hired a marketing company to examine Company P’s market at a cost of $125,000. The marketing report of the company is as follows:
- There will be a faster expansion in the upcoming 4 years
- The company will be able to sell 3,600, 4,300, 5,200, and 3,900 units for every year in the upcoming 4 years
- The premium price that is charged by the company is $750
- The year-end sales can be discounted
The company believes that the fixed cost of the project is $415,000 for a year, the variable cost is 15% of sales. The essential equipment for sales is $3.5 million the depreciation is based on the MACRS 3 year depreciation. At the project’s end the scrap value of the equipment is $350,000. The immediate requirement of the net working capital is $125,000. Company P’s tax rate is 38% and required rate of return is 13%.
MACRS depreciation table for three-year:
Year | MACRS 3 year percentage |
1 | 33.33% |
2 | 44.45% |
3 | 14.81% |
4 | 7.41% |
Computation of the net present value:
To compute the net present value, first it is necessary to find out the after tax salvage value of the equipment and operating cash flow of the project.
Formula to compute the taxes on the salvage value of the equipment:
Computation of the taxes on salvage value of the equipment:
Hence, the taxes on the salvage value of the equipment are - $133,000.
Formula to calculate the after tax salvage value of the equipment:
Computation of the after tax salvage value of the equipment:
Hence, the after tax salvage value is $217,000.
Computation of the total cash flow of the project:
Total cash flow of the project | |||||
Year 0 Amount in ($) | Year 1 Amount in ($) | Year 2 Amount in ($) | Year 3 Amount in ($) | Year 4 Amount in ($) | |
Revenues | 2700000 | 3225000 | 39,00,000 | 29,25,000 | |
Less: Fixed costs | 415000 | 415000 | 4,15,000 | 415000 | |
Variable costs | 405000 | 483750 | 5,85,000 | 438750 | |
Depreciation | 1166550 | 1555750 | 5,18,350 | 259350 | |
EBT | 713450 | 770500 | 23,81,650 | 1811900 | |
Less: Taxes | 271111 | 292790 | 905027 | 688522 | |
Net income | 442339 | 477710 | 1476623 | 1123378 | |
OCF | 1608889 | 2033460 | 1994973 | 1382728 | |
Capital spending | –3,500,000 | 217000 | |||
Land | –2,300,000 | 2400000 | |||
NWC | –125,000 | 125000 | |||
Total cash flow | –$5,925,000 | $16,08,889 | $20,33,460 | $19,94,973 | $41,24,728 |
Calculations that is necessary for the above table:
Computation of the revenue:
Computation of the variable cost:
Computation of the depreciation based on the MACRS 3 year depreciation:
Computation of the taxes:
Computation of the operating cash flow:
Formula to calculate the net present value of the project:
Computation of the net present value of the project:
Hence, the net present value of the project is $1,003,682.32.
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Chapter 10 Solutions
Fundamentals of Corporate Finance
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- Principles of Accounting Volume 2AccountingISBN:9781947172609Author:OpenStaxPublisher:OpenStax College