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.)

Answer 1

Assume that the cash inflows and outflows are real cash flows, we will not have to adjust the same with inflation because the discount rate given is real discount rate.

Depreciation = 190 million/4 = 47.5 million

Particulars	0	1	2	3	4
Initial Investment	(190000000)
Revenue (units*unit proice)		82925000	88275000	98975000	93625000
Labour Cost (labour hours*hourly rate)		(18386000)	(20047080)	(23086476)	(22202136)
Energy cost (Energy units*unit rate)		(1050000)	(1168020)	(1292176)	(1262099)
Depreciation		(47500000)	(47500000)	(47500000)	(47500000)
Cash flow before taxes	(190000000)	15989000	19559900	27096348	22660765
Cash flow after taxes (66%)		10552740	12909534	17883589	14956105
Depreciation		47500000	47500000	47500000	47500000
Net Cash Flow (A)	(190000000)	58052740	60409534	65383589	62456105
k = 4% (1/1.04^n) (B)	0	0.9615	0.9245	0.8890	0.8548
Net Cash Flow (A*B)	(190000000)	55817709	55848614	58126011	53387478

NPV = Cash Inflow - Cash Outflow

= $33,179,812