Question

Dickinson Brothers, Inc., is considering investing in a machine to produce computer keyboards. The price of the machine will be $1,700,000, and its economic life is five years. The machine will be fully depreciated by the straight-line method. The machine will produce 27,000 keyboards each year. The price of each keyboard will be $59 in the first year and will increase by 4 percent per year. The production cost per keyboard will be $26 in the first year and will increase by 5 percent per year. The project will have an annual fixed cost of $285,000 and require an immediate investment of $250,000 in net working capital. The corporate tax rate for the company is 25 percent. The appropriate discount rate is 9 percent. What is the NPV of the investment?

Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-1700000
Initial working capital		-250000
=Initial Investment outlay		-1950000
								100.00%
Sales			1593000	1656720	1722988.8	1791908.4	1863584.7
Profits	Sales-variable cost		891000	919620	949033.8	979255.6	1010299.3
Fixed cost			-285000	-285000	-285000	-285000	-285000
-Depreciation	Cost of equipment/no. of years		-340000	-340000	-340000	-340000	-340000	0	=Salvage Value
=Pretax cash flows			266000	294620	324033.8	354255.6	385299.3
-taxes	=(Pretax cash flows)*(1-tax)		199500	220965	243025.35	265691.7	288974.47
+Depreciation			340000	340000	340000	340000	340000
=after tax operating cash flow			539500	560965	583025.35	605691.7	628974.47
reversal of working capital							250000
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							250000
Total Cash flow for the period		-1950000	539500	560965	583025.35	605691.7	878974.47
Discount factor=	(1+discount rate)^corresponding period	1	1.09	1.1881	1.295029	1.4115816	1.538624
Discounted CF=	Cashflow/discount factor	-1950000	494954.1284	472153.02	450202.54	429087.27	571273.1
NPV=	Sum of discounted CF=	467670.0594