Question

Kopperud Electronics has an investment opportunity to produce a new HDTV. The required investment on January 1 of this year is $215 million. The firm will depreciate the investment to zero using the straight-line method over four years. The investment has no resale value after completion of the project. The firm has a 25 percent tax rate. The price of the product will be $575 per unit, in real terms, and will not change over the life of the project. Labor costs for Year 1 will be $16.70 per hour, in real terms, and will increase at 3 percent per year in real terms. Energy costs for Year 1 will be $4.90 per physical unit, in real terms, and will increase at 4 percent per year in real terms. The inflation rate is 6 percent per year. Revenues are received and costs are paid at year-end. Refer to the following table for the production schedule:

  

	Year 1		Year 2		Year 3		Year 4
Physical production, in units	185,000		205,000		220,000		175,000
Labor input, in hours	1,320,000		1,600,000		1,380,000		1,300,000
Energy input, physical units	230,000		245,000		275,000		260,000

  

The real discount rate for the project is 6 percent.

  

Calculate the NPV of this project.

Answer 1

Sol: Given Price per unit of Product in real term = $ 575;

Initial Outlay in real term = $ 215 million;

Tax Rate = 25%

Life of Project = 4 years

Salvage Value = 0

Labour Rate = $16.70 / Hour in Year-1 and thereafter will increase 3% p.a in real term

Energy Rate = $4.90 / Hour in Year-1 and thereafter will increase 4% p.a in real term

Calculation NPV at Real Discount Rate ($ in million)

Year	Production unit	Labour Hour	Energy input	Sales/Unit	Labour Rate	Energy rate	Sales ($)	Labour ($)	Energy ($)	Depreciation ($)	EBIT (1-Tax)	Cash Inflow	DCF @ 6 %	PV of CF
(a)	(b)	(c)	(d)	(e)	(f)	(g)	(h)= (b)* (e)	(i)= (c )*(f)	(j)= (d)*(g)	(k)	(l)=(h-i-j-k)*(1-0.25)	(m)=(l)+(k)	(n)	(o)= (m)*(n)
1	185000	1320000	230000	575.00	16.70	4.90	106.38	22.04	1.13	53.75	22.09	75.84	0.9434	71.55
2	205000	1600000	245000	575.00	17.20	5.10	117.88	27.52	1.25	53.75	26.52	80.27	0.8900	71.44
3	220000	1380000	275000	575.00	17.72	5.30	126.50	24.45	1.46	53.75	35.13	88.88	0.8396	74.63
4	175000	1300000	260000	575.00	18.25	5.51	100.63	23.72	1.43	53.75	16.29	70.04	0.7921	55.48
	PV of Cash Inflow													273.09

Thus, NPV of the Project = PV of Cash inflow- PV of Cash Outflow

= 273.09- 215.00

= $ 58.09

Therefore, the NPV of the Project is $ 58.09 million.