Question

Sanders Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $284,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $119,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 4 percent. Production costs at the end of the first year will be $44,000, in nominal terms, and they are expected to increase at 5 percent per year. The real discount rate is 7 percent. The corporate tax rate is 40 percent. Calculate the NPV of the project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Hi here we will use excel NPV formula table to find out the NPV

Here initital investment = $284,000

Revenue in first year =$119,000

inrease in revenue = 4%

hence next year revenue = 119,000*(1.04) = $123,760

and in the same way reveune increase for next 7 years

Cost for first year = $44,000

and it will increase at 5% hence cost at next year =44000*(1.05) = $46,200

hence Y1 operating profit = 119000-44000=75000

tax rate =40%

hence first year profit after tax= 75000*(1-0,4)= $45,0000

same way we will find out the Y1-Y7 Profit after tax

and then we will use NPV formula = -284000+NPV(7%,cash flow)

Below is the table with the data:

hence NPV for the project = $17,222.62

Thanks

Hi Thanks for your comments.

Sorry for the confusion.

I forgot to add 2 points here in this question thats why NPV is coming wrong.

First in the cash flow forgot to add depreciation values .

SInce there is no salvage value hence depreciation per year = 284000/7 = $40,571.43

So Profit before tax for first year will be =119,000- 44000-40571.43= $34,428.57

And Cash flow for first year = Profit after tax+Dep. = 20657.14+40571.43= 61228.57

Same way second point to note here is that Revenue and cost are given in nominal term here

so discount will also be taken as nominal

nominal discount rate =real discount rate +inflation =7+4 = 11%

so we will put these 2 things in excel here, below is the updated excel here:

So NPV =$24,172

Sorry for the confusion here.

Regards,