Question

Bright Lighting Ltd is considering a new range of product based on a specific type of intelligent stage lighting after extensive market research costing $60,000, which was paid yesterday. Bright expects that this range will increase the firm’s revenues by $1,565,000 in the first year of operations. Thereafter, revenues will only increase by 15% p.a. The additional material will cost $850,000 p.a., additional labour cost is expected to be $350,000 p.a. and other miscellaneous costs are estimated to be $52,000 p.a. After the first year, Bright expect these costs will increase by 2.5% p.a. each year. [Assume that all revenues are received and that all costs are paid at the end of each year.] The initial outlay of $2,125,000 will be depreciated on a straight-line basis to zero salvage value over the 8-year productive life of the project. It is estimated the various components of equipment can be sold for $100,000 at the completion of the project. The firm requires a 12.5% p.a. required rate of return and the tax rate is 30%. Tax is paid in the year in which net earnings are received. Calculate the incremental cash flows for each year (Y0 to Y8 inclusive). PLZ consider Y0. Calculate the net present value, that is, the net benefit or net loss in present value terms of the project.

Answer 1

Initial outley			=	$2,125,000
Depreciation on initialoutlay			=	2125000/8
			=	$265,625
salvage value			=	100,000
Aftertax value of salvage			=	100,000*(1-0.3)=$70,000
	Calculation of Incremental cashflow
	Year	0	1	2	3	4	5	6	7	8
	Sales		1,565,000	1799750	2069712.5	2380169.375	2737194.781	3147773.998	3619940.098	4162931.113
(a)	Cost of material		850,000	871250	893031.25	915357.0313	938240.957	961696.981	985739.4055	1010382.891
(b)	Additionallabour		350,000	358750	367718.75	376911.7188	386334.5117	395992.8745	405892.6964	416040.0138
(.c)	Other misc.cost		52,000	53300	54632.5	55998.3125	57398.27031	58833.22707	60304.05775	61811.65919
(d)	Depreciation		$265,625	$265,625	$265,625	$265,625	$265,625	$265,625	$265,625	$265,625
(.e)	Net profit(a-b-c-d)		$47,375	$250,825	$488,705	$766,277	$1,089,596	$1,465,626	$1,902,379	$2,409,072
(f)	less:tax (e*0.3)		$14,212.50	$75,247.50	$146,611.50	$229,883.19	$326,878.81	$439,687.77	$570,713.68	$722,721.46
(h)	Profit aftertax		$33,162.50	$175,577.50	$342,093.50	$536,394.12	$762,717.23	$1,025,938.14	$1,331,665.26	$1,686,350.08
(i)	Salvage value after tax									70,000
(j)	Initialoutlay *	-2,125,000
(k)	Cashflow (h+d+i+j)	-2,125,000	$298,787.50	$441,202.50	$607,718.50	$802,019.12	$1,028,342.23	$1,291,563.14	$1,597,290.26	$2,021,975.08
(l)	[email protected]%	1	0.8889	0.7901	0.7023	0.6243	0.5549	0.4933	0.4385	0.3897
(m)	PV (k*l)	-2125000	265588.89	348604.44	426820.13	500696.59	570656.88	637089.59	700351.70	788053.35
	Net present value (NPV) =	sum of all PV
	=	-2125000+265588.89+348604.44+426820.13+500696.59+570656.88+637089.59+700351.7+788053.35
	=	2112861.57
*Reseach cost is sunk cost.It will not be recovered if we do not do the project,hence it is ignored.
There is tax treatment on salavge value because we have claimed depreciation on entire initial outlay in 8 years.
hence the amount realised as salavge value is a capital gain and hence taxed.
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