Question
In: Finance
Topperton Company has developed a new industrial product. An outlay of $8 million is required for...
Topperton Company has developed a new industrial product. An outlay of $8 million is required for equipment to produce the new product, and additional net working capital of $400,000 is required to support production and marketing. In addition, a one-time $400,000 (before-tax) expense will be incurred the year that the equipment is placed into service. The equipment will be depreciated on a straight-line basis to a zero book value over 6 years. Although the depreciable life is 6 years, the project is expected to have a productive life of 8 years, and it is estimated that the equipment can be sold for $1 million at that time. Revenues minus expenses are expected to be $3 million per year. The cost of capital for this project is 14%, and the relevant tax rate is 30%. What is the NPV of the new product?
Group of answer choices
$2,956,923
$3,326,891
$3,002,696
None of these
Solutions
Expert Solution
Depreciation schedule is below:
| Straight line method | ||||
| Year | Opening balance | Investment | Depreciation | Closing balance |
| 0 | 8400000 | 8400000 | ||
| 1 | 8400000 | 1400000 | 7000000 | |
| 2 | 7000000 | 1400000 | 5600000 | |
| 3 | 5600000 | 1400000 | 4200000 | |
| 4 | 4200000 | 1400000 | 2800000 | |
| 5 | 2800000 | 1400000 | 1400000 | |
| 6 | 1400000 | 1400000 | 0 |
- Investment = Cost + Service expense
- Depreciation = Investment/life
- Opening balance = previous year's closing balance
- Closing balance = Opening balance+investment - depreciation
Following is the NPV calculation:
| Particulars | Remark | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 |
| EBITDA | Sales-Total VC-Fixed Cost | $ 30,00,000.00 | $ 30,00,000.00 | $ 30,00,000.00 | $ 30,00,000.00 | $ 30,00,000.00 | $ 30,00,000.00 | $ 30,00,000.00 | $ 30,00,000.00 | |
| Depreciation | Given | $ 14,00,000.00 | $ 14,00,000.00 | $ 14,00,000.00 | $ 14,00,000.00 | $ 14,00,000.00 | $ 14,00,000.00 | |||
| EBT | EBITDA-Depreciation | $ 16,00,000.00 | $ 16,00,000.00 | $ 16,00,000.00 | $ 16,00,000.00 | $ 16,00,000.00 | $ 16,00,000.00 | $ 30,00,000.00 | $ 30,00,000.00 | |
| Tax | 30% x EBT | $ 4,80,000.00 | $ 4,80,000.00 | $ 4,80,000.00 | $ 4,80,000.00 | $ 4,80,000.00 | $ 4,80,000.00 | $ 9,00,000.00 | $ 9,00,000.00 | |
| EAT | EBT-Tax | $ 11,20,000.00 | $ 11,20,000.00 | $ 11,20,000.00 | $ 11,20,000.00 | $ 11,20,000.00 | $ 11,20,000.00 | $ 21,00,000.00 | $ 21,00,000.00 | |
| Depreciation | Added back as non cash | $ 14,00,000.00 | $ 14,00,000.00 | $ 14,00,000.00 | $ 14,00,000.00 | $ 14,00,000.00 | $ 14,00,000.00 | $ - | $ - | |
| OCF | EAT+Depreciation | $ 25,20,000.00 | $ 25,20,000.00 | $ 25,20,000.00 | $ 25,20,000.00 | $ 25,20,000.00 | $ 25,20,000.00 | $ 21,00,000.00 | $ 21,00,000.00 | |
| FCINV | Given | $ -84,00,000.00 | ||||||||
| WCINV | Given | $ -4,00,000.00 | $ - | $ - | $ 4,00,000.00 | |||||
| Salvage value | Given | $ 10,00,000.00 | ||||||||
| Tax on profit on sale | At 30% on SP - BV | $ -3,00,000.00 | ||||||||
| FCF | OCF+FCINV+WCINV+Salvage Value+Tax on profit on sale | $ -88,00,000.00 | $ 25,20,000.00 | $ 25,20,000.00 | $ 25,20,000.00 | $ 25,20,000.00 | $ 25,20,000.00 | $ 25,20,000.00 | $ 21,00,000.00 | $ 32,00,000.00 |
| Discount factor Formula | at 14% | 1/(1+0.14)^0 | 1/(1+0.14)^1 | 1/(1+0.14)^2 | 1/(1+0.14)^3 | 1/(1+0.14)^4 | 1/(1+0.14)^5 | 1/(1+0.14)^6 | 1/(1+0.14)^7 | 1/(1+0.14)^8 |
| Discount factor | Calculated using above formula | 1 | 0.877192982 | 0.769467528 | 0.674971516 | 0.592080277 | 0.519368664 | 0.455586548 | 0.399637323 | 0.350559055 |
| DCF | FCF x Discount Factor | $ -88,00,000.00 | $ 22,10,526.32 | $ 19,39,058.17 | $ 17,00,928.22 | $ 14,92,042.30 | $ 13,08,809.03 | $ 11,48,078.10 | $ 8,39,238.38 | $ 11,21,788.98 |
| NPV = sum of all DCF | $ 29,60,469.49 |
So the correct answer is none of these as NPV is 29,60,469.49
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