Question

Kingston Kiteboards Incorporated (KKI) has been experiencing very strong demand for its products as kite-boarding continues to take away market share from windsurfing. The company is considering a new facility to manufacture an improved line of kites and another facility to produce a new line of boards. The company estimates that the new kite facility will cost $1,350,000 to construct in Year 0 with a salvage value of $160,000 in Year 15. The board manufacturing facility will cost $1,700,000 in Year 0 with a salvage value of $180,000 in Year 15. Combined annual revenue for the new kites and boards is expected to be $750,000 with annual combined operating costs of $270,000 each year. Management has identified a piece of land where both facilities could be built that could be purchased for $550,000 in Year 0. The management team estimates that the land may be sold for the same value of $550,000 at the end of Year 15. The company uses a discount rate of 9% and a tax rate of 30%. Assume that the CCA rate of 20% can be applied to the land and the manufacturing facilities.

a. Use the present value tax shield approach to determine the net present value (NPV) of combined project involving both new manufacturing facilities. Should KKI proceed with the investment using these assumptions?

b. The management team at KKI has decided to take a more conservative approach with some of its estimates. The team feels that the facilities may only last for 13 years and the operating costs may amount to $300,000 per year. However, the company has successfully negotiated a construction cost of $1,200,000 for the kite facility and $1,400,000 for the board facility. (Assume the salvage values are unchanged.) Using the present value tax shield approach, what is the total NPV with these assumptions? Should the company proceed under these revised assumptions?

Answer 1

a)
					20%	30%			9%
Year	Cost	Annual Revenue	Annual Cost	Net income	Depreciation	Depreciation tax shield	Salvage value	Cash flow	Discount Factor	Present Value
0	(3,600,000.00)							(3,600,000.00)	1.0000	(3,600,000.00)
1		750,000.00	270,000.00	480,000.00	720,000.00	216,000.00		696,000.00	0.9174	638,532.11
2		750,000.00	270,000.00	480,000.00	576,000.00	172,800.00		652,800.00	0.8417	549,448.70
3		750,000.00	270,000.00	480,000.00	460,800.00	138,240.00		618,240.00	0.7722	477,394.71
4		750,000.00	270,000.00	480,000.00	368,640.00	110,592.00		590,592.00	0.7084	418,390.26
5		750,000.00	270,000.00	480,000.00	294,912.00	88,473.60		568,473.60	0.6499	369,468.83
6		750,000.00	270,000.00	480,000.00	235,929.60	70,778.88		550,778.88	0.5963	328,411.45
7		750,000.00	270,000.00	480,000.00	188,743.68	56,623.10		536,623.10	0.5470	293,551.21
8		750,000.00	270,000.00	480,000.00	150,994.94	45,298.48		525,298.48	0.5019	263,629.60
9		750,000.00	270,000.00	480,000.00	120,795.96	36,238.79		516,238.79	0.4604	237,690.68
10		750,000.00	270,000.00	480,000.00	96,636.76	28,991.03		508,991.03	0.4224	215,003.31
11		750,000.00	270,000.00	480,000.00	77,309.41	23,192.82		503,192.82	0.3875	195,003.75
12		750,000.00	270,000.00	480,000.00	61,847.53	18,554.26		498,554.26	0.3555	177,253.35
13		750,000.00	270,000.00	480,000.00	49,478.02	14,843.41		494,843.41	0.3262	161,407.35
14		750,000.00	270,000.00	480,000.00	39,582.42	11,874.73		491,874.73	0.2992	147,191.77
15		750,000.00	270,000.00	480,000.00	31,665.93	9,499.78	890,000.00	1,379,499.78	0.2745	378,725.17
a)	Net Present Value:	1,251,102.27
	Since NPV is positive, it should be accepted

Note A:
Kite Facility	1350000
Board Manufacturing facility	1700000
Land	550000
Total Cost	3600000
Kite Facility	160000
Board Manufacturing facility	180000
Land	550000
Total Salvage Value	890000

b)
					20%	30%			9%
Year	Cost	Annual Revenue	Annual Cost	Net income	Depreciation	Depreciation tax shield	Salvage value	Cash flow	Discount Factor	Present Value
0	(3,150,000.00)							(3,150,000.00)	1	(3,150,000.00)
1		750,000.00	300,000.00	450,000.00	630,000.00	189,000.00		639,000.00	0.91743119	586,238.53
2		750,000.00	300,000.00	450,000.00	504,000.00	151,200.00		601,200.00	0.84167999	506,018.01
3		750,000.00	300,000.00	450,000.00	403,200.00	120,960.00		570,960.00	0.77218348	440,885.88
4		750,000.00	300,000.00	450,000.00	322,560.00	96,768.00		546,768.00	0.70842521	387,344.24
5		750,000.00	300,000.00	450,000.00	258,048.00	77,414.40		527,414.40	0.64993139	342,783.17
6		750,000.00	300,000.00	450,000.00	206,438.40	61,931.52		511,931.52	0.59626733	305,248.04
7		750,000.00	300,000.00	450,000.00	165,150.72	49,545.22		499,545.22	0.54703424	273,268.34
8		750,000.00	300,000.00	450,000.00	132,120.58	39,636.17		489,636.17	0.50186628	245,731.88
9		750,000.00	300,000.00	450,000.00	105,696.46	31,708.94		481,708.94	0.46042778	221,792.18
10		750,000.00	300,000.00	450,000.00	84,557.17	25,367.15		475,367.15	0.42241081	200,800.22
11		750,000.00	300,000.00	450,000.00	67,645.73	20,293.72		470,293.72	0.38753285	182,254.27
12		750,000.00	300,000.00	450,000.00	54,116.59	16,234.98		466,234.98	0.35553473	165,762.72
13		750,000.00	300,000.00	450,000.00	43,293.27	12,987.98	890,000.00	1,352,987.98	0.32617865	441,315.79

b)	Net Present Value:	1,149,443.27
	Since NPV is positive, it should be accepted

Note B:
Kite Facility	1200000
Board Manufacturing facility	1400000
Land	550000
Total Cost	3150000
Kite Facility	160000
Board Manufacturing facility	180000
Land	550000
Total Salvage Value	890000