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
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.
Want to see more full solutions like this?
Chapter 10 Solutions
Fundamentals of Corporate Finance
- Q.3 (x1=70000 x2=10%) The IPS company has installed a system to help reduce the number of defective products. The capital investment in the system is $X1, and the projected annual savings are tabled below. The system's market value at the EOY five is negligible, and the MARR is x2% per year A. What is the FW of this investment? Based on econonical deciston rule, is this a good investment. b. What is the IRR of the system? Based on economical decision rule, is this a good investmentr. C. What is the discounted pavback period for this investment.arrow_forwardA3 5b 5. We have two independent and mutually exclusive projects, A and B. Project A requires an initial investment of $1500, and will yield $800 of cash inflows for the next three years. Project B requires an initial investment of $5000, and will yield $1,500 of cash inflows for the next five years. The required return on each project is 10%. b. What is the problem with using the NPV investment criterion in this case? What alternative criterion should be used?arrow_forwardTime remaining: 00:09:48 Economics Mark is working to create the "metaverse". He has already spent $2 billion on fixed costs. With 30% probability, the metaverse will be a big success, in which case he can choose whether to spend $5 billion on engineering to earn revenues of $20 billion. (If he chooses not to spend all of that amount of engineering, then his revenue from the metaverse will be $0.) With 70% probability, the metaverse will not be popular, in which case Mark will choose whether to spend $5 billion on engineering in order to receive $3 billion in revenue. Assuming that Mark maximizes profit, what is the expected value of his metaverse project? Choose the nearest answer. a. $2.5 billion b. $3.1 billion c. -$2 billion d. $4.5 billion e. $1.1 billionarrow_forward
- H2. .  Time remaining: 00:09:29 Finance You own a coal mining company and are considering opening a new mine. The mine itself will cost $120 million to open. If this money is spent immediately, the mine will generate $22 million for the next 10 years. After that, the coal will run out and the site must be cleaned and maintained at environmental standards. The cleaning and maintenance are expected to cost $1.8 million per year in perpetuity. What does the IRR rule say about whether you should accept this opportunity? (Hint: Consider the number of sign changes in the cash flows.) If the cost of capital is 7.6%, what does the NPV rule say? Question content area bottom Part 1) What does the IRR rule say about whether you should accept this opportunity? (Select the best choice below.) A. Accept the opportunity because the IRR is greater than the cost of capital. B. There are two IRRs, so you cannot use the IRR as a criterion for accepting the opportunity. C. Reject…arrow_forwardquestion 18 Nirvana Chip Designs has finished designing its next generation of chips, the XJ5000 series and is getting ready to start production. As the analyst on the project, you are required to prepare pro forma free cash flows. Which of the following are relevant to your analysis? a. Design cost for the chips b. Potential lost sales of the XJ4000 chips c. Proportional cost of the corporate jet lease d. Start-up investment in raw materials e. Upgrades to the chip fabrication facility required if the chip is produced f. Market research done to guide the development of the new chip g. Market value of land and buildings where new chip will be produced 1. Design cost for the chips. (Select the best choice below.) A. This is relevant because it is an investment in working capital. B. This is relevant as it represents cannibalization of existing sales. C. This is irrelevant because it is a sunk cost. D. This is irrelevant as it represents existing overhead.…arrow_forwardA3 8aiv You are considering a new product launch. The project will cost $680,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 100 units per year, price per unit will be $19,000, variable cost per unit will be $14,000, and fixed costs will be $150,000 per year. The required return on the project is 15%, and the relevant tax rate is 35%. Ignore the half-year rule for accounting for depreciation. a. Calculate the following six numbers for this project. Round your answers to two decimal places. (iv) Discounted payback period (in years)arrow_forward
- [6:46 am, 15/01/2022] Mahmoud: 19. Cost of Capital. Pollution Busters, Inc., is considering a purchase of 10 additional carbon sequesters for $100,000 apiece. The sequesters last for only 1 year until saturated with carbon. Then the carbon is removed and sold. (O LO4) a. Suppose the government guarantees the price of carbon. At this price, the payoff after 1 year is guaranteed to be $115,000. How would you determine the opportunity cost of capital for this investment? b. Suppose instead that the sequestered carbon has to be sold on the London Carbon Exchange. Carbon prices have been extremely volatile, but Pollution Busters' CFO learns that average rates of return from investment on that exchange have been about 20%. She thinks this is a reasonable forecast for the future. What is the opportunity cost of capital in this case? Is the purchase of an additional sequester a worthwhile capital investment if she expects that the price of extracted carbon will $115,000? please show the strpsarrow_forwardQuestion 33 Brandt Enterprises is considering a new project that has a cost of $1,000,000, and the CFO set up the following simple decision tree to show its three most likely scenarios. The firm could arrange with its work force and suppliers to cease operations at the end of Year 1 should it choose to do so, but to obtain this abandonment option, it would have to make a payment to those parties. How much is the option to abandon worth to the firm? a. $64.08 b. $55.08 c. $67.29 d. $61.03 e. $57.98arrow_forwardQ No. 3 A construction company is deciding to undertake a project. The project is quite profitable as it will generate net cash inflows of $20 million per year for 5 years. However, it will cause pollution to the nearby residents. The company can mitigate this pollution by investing additional 10 million at Year 0 but legally it is not compulsory for it to do so. Undertaking this project would cost $60 million without mitigation. If the firm does invest in mitigation, the annual cash inflows would be $22 million. The risk adjusted WACC is 12%. A) Calculate the NPV and IRR with and without mitigation. B) Should the project be undertaken? If so, should the firm do mitigation?arrow_forward
- A3 5c. 5. We have two independent and mutually exclusive projects, A and B. Project A requires an initial investment of $1500, and will yield $800 of cash inflows for the next three years. Project B requires an initial investment of $5000, and will yield $1,500 of cash inflows for the next five years. The required return on each project is 10%. c. Which project should be chosen?arrow_forwardProject Evaluation [LO1] Dog Up! Franks is looking at a new sausage systemwith an installed cost of $460,000. This cost will be depreciated straight-line to zero over the project's five-year life, at the end of which the sausage system can be scrapped for $55,000. The sausage system will save the firm $155,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $29,000. If the tax rate is 21 percent and the discount rate is 10 percent, what is the NPV of this project?arrow_forwardshow all excel formulas/ work answering the following: LO2 27. Project Analysis You are considering a new product launch. The project will cost $780,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 170 units per year, price per unit will be $16,300, variable cost per unit will be $11,100, and fixed costs will be $535,000 per year. The required return on the project is 11 percent, and the relevant tax rate is 21 percent. a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate within +10 percent. What are the best and worst cases for these projections? What is the base-case NPV? What are the best- case and worst-case scenarios? b. Evaluate the sensitivity of your base-case NPV to changes in fixed costs.arrow_forward