Question

O'Bannon Electronics has an investment opportunity to produce a new HDTV. The required investment on January 1 of this year is $190 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 is in the 34 percent tax bracket. The price of the product will be $535 per unit, in real terms, and will not change over the life of the project. Labor costs for Year 1 will be $15.85 per hour, in real terms, and will increase at 2 percent per year in real terms. Energy costs for Year 1 will be $4.20 per physical unit, in real terms, and will increase at 3 percent per year in real terms. The inflation rate is 5 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	155,000		165,000		185,000		175,000
Labor input, in hours	1,160,000		1,240,000		1,400,000		1,320,000
Energy input, physical units	250,000		270,000		290,000		275,000

  

The real discount rate for the project is 4 percent.

  

Calculate the NPV of this project. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

NPV

$

Answer 1

Year	0	1	2	3	4
Physical production, in units		155,000	165,000	185,000	175,000
Labor input, in hours		1,160,000	1,240,000	1,400,000	1,320,000
Energy input, physical units		250,000	270,000	290,000	275,000
Investment	-190,000,000
Sales		82,925,000	88,275,000	98,975,000	93,625,000
Labor Cost		18,386,000	20,047,080	23,086,476	22,202,594
Energy Costs		1,050,000	1,168,020	1,292,176	1,262,100
Depreciation		47,500,000	47,500,000	47,500,000	47,500,000
EBT		15,989,000	19,559,900	27,096,348	22,660,307
Tax (34%)		5,436,260	6,650,366	9,212,758	7,704,504
Net Income		10,552,740	12,909,534	17,883,590	14,955,802
Cash Flows	-190,000,000	58,052,740	60,409,534	65,383,590	62,455,802
NPV	33,185,206.89

Sales = Physical Production x Price, where Price is constant for the entire project

Labor Cost = Labor input x Cost per hour, where cost per hour increases by 2% each year.

Energy Cost = Energy input x Cost per hour, where cost per hour increases by 3% each year.

Depreciation = Investment / No. of years

Cash Flow = Investment + Net Income + Depreciation

NPV can be calculated using NPV function in excel or using formula with 4% discount rate.

NPV = - CF0 + CF1 / (1 + r) + CF2 / (1 + r)^2 + CF3 / (1 + r)^3 + CF4 / (1 + r)^4

Here, we have considered all values in real terms and hence, inflation is not considered in the analysis.