Question

A new project is being considered and the data is given below. The asset has a 3-year tax life, would be depreciated on a straight-line basis over the project's 3-year life, and would have a zero salvage value after Year 3. Operating working capital change would be of $1000. Revenues and other operating costs will be constant over the project'slife. If the units decline by 45% from the expected level, find the change in NPV.Investment cost $60,000 Units2,800 Price/Unit$25.00 Fixed costs$10,000 V cost/unit $5.375 Annual depreciation$20,000 WACC10.0% Tax rate40.0%

Answer 1

	Given :
	Annual Depreciation :	20,000
	Tax rate	40%

	Annual Depreciation Tax saving	8,000
	Sales Details in two scenario	Full sales	Sales with 45% decline
	Annual Sales Units	2,800	1,540
	Price/Unit	$                25.00	$                  25.00
a	Annual sales Revenue	70,000	38,500
	Variable cost per unit	$                5.375	$                  5.375
b	Annual variable cost	$         15,050.00	$             8,277.50
c	Annual fixed cost	$         10,000.00	$          10,000.00
d	EBIT (w/o depreciation)=a-b-c	$         44,950.00	$          20,222.50
e	Tax @40%	$         17,980.00	$             8,089.00
f	After Tax Income	$         26,970.00	$          12,133.50

	NPV with full sales	Year 0	Year 1	Year 2	Year 3
	Initial Investment
	Investment cost	(60,000)
	Investment in NWC	(1,000)
a	Total Initial Investment	(61,000)
	Cash flow from Operations
	After Tax net Income		26,970.00	26,970.00	26,970.00
	Depreciation Tax savings		8,000	8,000	8,000
b	Total Cash flow from Operations		34,970	34,970	34,970
	Terminal Cash fow
	Return of NWC				1,000
c	Total Terminal Cash flow				1,000
d	Total Free Cash flow from Project =a+b+c	(61,000)	34,970	34,970	35,970
e	PV factor @WACC 10%=1/1.10^n	1	0.9091	0.8264	0.7513
f	PV of FCF =d*e=	(61,000)	31,791	28,901	27,025
g	NPV =Sum of PV of FCF =	26,716.53

	NPV with 45% less sales	Year 0	Year 1	Year 2	Year 3
	Initial Investment
	Investment cost	(60,000)
	Investment in NWC	(1,000)
a	Total Initial Investment	(61,000)
	Cash flow from Operations
	After Tax net Income		12,133.50	12,133.50	12,133.50
	Depreciation Tax savings		8,000	8,000	8,000
b	Total Cash flow from Operations		20,134	20,134	20,134
	Terminal Cash fow
	Return of NWC				1,000
c	Total Terminal Cash flow				1,000
d	Total Free Cash flow from Project =a+b+c	(61,000)	20,134	20,134	21,134
e	PV factor @WACC 10%=1/1.10^n	1	0.9091	0.8264	0.7513
f	PV of FCF =d*e=	(61,000)	18,303	16,639	15,878
g	NPV =Sum of PV of FCF =	(10,179.65)

NPV with full sales	26,716.53
NPV with 45% reduced sales	(10,179.65)
Change in NPV =	36,896.18