Question

A business opportunity has presented itself to you and one of your classmates. Your opportunity is to enter the fast-growing craft beer industry. Your projected sales in the first year is 7500 kegs. Your projected growth rate is 5 percent. Entering the business will require $35,000 of net working capital. Total fixed costs are $95,000. Variable production costs are $32 per keg and keg sales are priced at $56 each. The equipment to begin production is $175,000. The equipment will be depreciated using straight line depreciation over a five year life and has no salvage value. The tax rate is 35 percent and the required return is 23 percent. What is the NPV of the project and should you pursue the project?

Please show full work

$35,512.45 Yes, take the project.

$18,991.73 Yes, take the project

-$15,351.31 No, do not take the project.

$8,695.45 Yes, take the project.

Answer 1

Tax rate		35%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Total
Cost		$       175,000	$      175,000	$       175,000	$       175,000	$      175,000
Dep Rate		20.00%	20.00%	20.00%	20.00%	20.00%
Depreciation	Cost * Dep rate	$         35,000	$        35,000	$         35,000	$         35,000	$        35,000	$       175,000
Calculation of after-tax salvage value
Cost of machine			$      175,000
Depreciation			$      175,000
WDV	Cost less accumulated depreciation	$                -
Sale price			$                -
Profit/(Loss)	Sale price less WDV	$                -
Tax	Profit/(Loss)*tax rate	$                -
Sale price after-tax	Sale price less tax		$                -
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5
No of Kegs		7,500	7,875	8,269	8,682	9,116
Selling price		$                56	$               56	$                56	$                56	$               56
Operating cost		$                32	$               32	$                32	$                32	$               32
Sale		$       420,000	$      441,000	$       463,050	$       486,203	$      510,513
Less: Operating Cost		$       240,000	$      252,000	$       264,600	$       277,830	$      291,722
Contribution		$       180,000	$      189,000	$       198,450	$       208,373	$      218,791
Less: Fixed cost		$         95,000	$        95,000	$         95,000	$         95,000	$        95,000
Less: Depreciation		$         35,000	$        35,000	$         35,000	$         35,000	$        35,000
Profit before tax (PBT)		$         50,000	$        59,000	$         68,450	$         78,373	$        88,791
Tax@35%	PBT*Tax rate	$         17,500	$        20,650	$         23,958	$         27,430	$        31,077
Profit After Tax (PAT)	PBT - Tax	$         32,500	$        38,350	$         44,493	$         50,942	$        57,714
Add Depreciation	PAT + Dep	$         35,000	$        35,000	$         35,000	$         35,000	$        35,000
Cash Profit after-tax		$         67,500	$        73,350	$         79,493	$         85,942	$        92,714
Calculation of NPV
						23.00%
Year		Capital	Working capital	Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0		$     (175,000)	$       (35,000)		$     (210,000)	1.0000	$(210,000.00)
1				$         67,500	$         67,500	0.8130	$    54,878.05
2				$         73,350	$         73,350	0.6610	$    48,483.05
3				$         79,493	$         79,493	0.5374	$    42,717.99
4				$         85,942	$         85,942	0.4369	$    37,547.90
5		$                 -	$        35,000	$         92,714	$       127,714	0.3552	$    45,364.75
					Net Present Value	$    18,991.73
Since NPV is positive, the project should be taken up so option 2 is the right answer.