Question

Dickinson Brothers, Inc., is considering investing in a machine to produce computer keyboards. The price of the machine will be $1,500,000, and its economic life is five years. The machine will be fully depreciated by the straight-line method. The machine will produce 29,000 keyboards each year. The price of each keyboard will be $52 in the first year and will increase by 4 percent per year. The production cost per keyboard will be $22 in the first year and will increase by 5 percent per year. The project will have an annual fixed cost of $265,000 and require an immediate investment of $230,000 in net working capital. The corporate tax rate for the company is 21 percent. The appropriate discount rate is 9 percent.

  

What is the NPV of the investment?

Answer 1

i) Initial investment in year zero

Particulars	US$
Price of machine	15,00,000
Investment in working capital	2,30,000
	17,30,000

ii)

Depreciation per year (US$15,00,000/5 YEARS)

US$3,00,000

iii) Calculation of total cash inflows

	YEAR
Particulars	1	2	3	4	5
sales per unit	52	54	56	58	61
Less: production cost per unit	22	23	24	25	27
contribution per unit (a-b)	30	31	32	33	34
Quantity	29,000	29,000	29,000	29,000	29,000
	US$	US$	US$	US$	US$
Total contribution	8,70,000	8,98,420	9,27,420	9,57,580	9,88,610
Less: fixed costs	2,65,000	2,65,000	2,65,000	2,65,000	2,65,000
Less : Depreciation	3,00,000	3,00,000	3,00,000	3,00,000	3,00,000
Total profit before tax	3,05,000	3,33,420	3,62,420	3,92,580	4,23,610
less : Tax @21%	64,050	70,018	76,108	82,442	88,958
Total profit after tax	2,40,950	2,63,402	2,86,312	3,10,138	3,34,652
Add: Depreciation (note ii)	3,00,000	3,00,000	3,00,000	3,00,000	3,00,000
Total cash inflows	6,05,000	6,33,420	6,62,420	6,92,580	7,23,610

iv) Calculation of NET PRESENT VALUE

Year	Particulars	Discount rate	Discounted Cash inflow (US$)
0	Initial investment (Note i))	1	-17,30,000
1	Cash inflows ( note iii)	0.91743	6,05,000
2	Cash inflows ( note iii)	0.84168	6,33,420
3	Cash inflows ( note iii)	0.77218	6,62,420
4	Cash inflows ( note iii)	0.70842	6,92,580
5	Cash inflows ( note iii)	0.64993	7,23,610
	NET PRESENT VALUE		15,87,030

Assumtions:

1. It is assumed that machinery would not have any salvage value at the end of year 5.