Question

With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital, they decided to focus on surf print table and floor lamps to accent people’s homes. They projected unit sales of these lamps to be 10,200 in the first year, with growth of 7 percent each year for the next five years. Production of these lamps will require $49,000 in net working capital to start. Total fixed costs are $131,000 per year, variable production costs are $18 per unit, and the units are priced at $60 each. The equipment needed to begin production will cost $585,000. The equipment will be depreciated using the straight-line method over a 5-year life and is not expected to have a salvage value. The tax rate is 22 percent and the required rate of return is 17 percent. What is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.

Answer 1

Answer 2

Ref	Particulars		Year 1	Year 2	Year 3	Year 4	Year 5
a	Sales		$       6,12,000.00	$           6,54,840.00	$    7,00,678.80	$    7,49,726.32	$    8,02,207.16
	Variable costs		$     (1,83,600.00)	$          (1,96,452.00)	$   (2,10,203.64)	$   (2,24,917.89)	$   (2,40,662.15)
	Fixed costs		$     (1,31,000.00)	$          (1,31,000.00)	$   (1,31,000.00)	$   (1,31,000.00)	$   (1,31,000.00)
b	Depreciation		$     (1,17,000.00)	$          (1,17,000.00)	$   (1,17,000.00)	$   (1,17,000.00)	$   (1,17,000.00)
c=a-b	Profit before tax		$       1,80,400.00	$           2,10,388.00	$    2,42,475.16	$    2,76,808.42	$    3,13,545.01
	Profit after tax		$       1,40,712.00	$           1,64,102.64	$    1,89,130.62	$    2,15,910.57	$    2,44,565.11
	Add depreciation		$       1,17,000.00	$           1,17,000.00	$    1,17,000.00	$    1,17,000.00	$    1,17,000.00
	Add: working capital		$                        -	$                             -	$                      -	$                      -	$        49,000.00
	Free cash flow		$       2,57,712.00	$           2,81,102.64	$    3,06,130.62	$    3,32,910.57	$    4,10,565.11
d	Present value factor@ 17.0%		0.854700855	0.730513551	0.624370556	0.533650048	0.456111152
e=c*d	Present value of annual cashflows		$       2,20,266.67	$           2,05,349.29	$    1,91,138.95	$    1,77,657.74	$    1,87,263.32
	Total present value of annual cash inflows		$       9,81,675.97
	Investment:
	Equipment		$     (5,85,000.00)
	Working capital		$        (49,000.00)
	NPV		$       3,47,675.97

NPV is:

3,47,675.97

Answer 3

NPV is the difference between the sum of present value of operating cash flows and initial investment or cash outflows at Year 0.

sum of present value of operating cash flows = year 1 operating cash flow/(1+required rate of return) + year 2 operating cash flow/(1+required rate of return)² .... + year 6 operating cash flow/(1+required rate of return)⁶

initial investment includes cost of equipment and working capital investment.

equipment has zero salvage value at the end of its 5-year life. so there will be no recovery from sale of equipment.

the NPV of this project is $487,298.79.

	Years	0	1	2	3	4	5	6	Total
	Cost of equipment	-$585,000	0	0	0	0	0	0	-$585,000
	net working capital	-$49,000	0	0	0	0	0	0	-$49,000
	Sales quantity	0	10,200	10,914	11,678	12,495	13,370	14,306
	Sales price/unit	0	$60.00	$60.00	$60.00	$60.00	$60.00	$60.00
	Variable cost/unit	0	$18.00	$18.00	$18.00	$18.00	$18.00	$18.00
	Sales	$0	$612,000	$654,840	$700,679	$749,726	$802,207	$858,362	$4,377,814
Less:	Variable cost	$0	$183,600	$196,452	$210,204	$224,918	$240,662	$257,508	$1,313,344
Less:	Fixed cost	$0	$131,000	$131,000	$131,000	$131,000	$131,000	$131,000	$786,000
Less:	Depreciation	$0	$117,000	$117,000	$117,000	$117,000	$117,000	$0	$585,000
	Pre-tax cash flow	$0	$180,400	$210,388	$242,475	$276,808	$313,545	$469,853	$1,693,470
Less:	Taxes @22%	$0	$39,688	$46,285	$53,345	$60,898	$68,980	$103,368	$372,563
	After-tax cash flow	$0	$140,712	$164,103	$189,131	$215,911	$244,565	$366,485	$1,320,906
Add back:	Depreciation	$0	$117,000	$117,000	$117,000	$117,000	$117,000	$0	$585,000
Add:	recovery of net working capital	$0	$0	$0	$0	$0	$0	$49,000	$49,000
	Operating cash flow	-$634,000	$257,712	$281,103	$306,131	$332,911	$361,565	$415,485	$1,320,906
	NPV	$487,298.79

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