Question

Aday Acoustics, Inc., projects unit sales for a new 7-octave voice emulation implant as follows:

Year		Unit Sales
1			74,100
2			79,500
3			85,000
4			82,400
5			69,100

Production of the implants will require $1,470,000 in net working capital to start and additional net working capital investments each year equal to 10 percent of the projected sales increase for the following year. Total fixed costs are $3,750,000 per year, variable production costs are $142 per unit, and the units are priced at $324 each. The equipment needed to begin production has an installed cost of $18,400,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as 7-year MACRS property. In five years, this equipment can be sold for about 15 percent of its acquisition cost. The company is in the 22 percent marginal tax bracket and has a required return on all its projects of 16 percent. MACRS schedule.

  

What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

What is the IRR of the project? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

In years 1 and 2, additional working capital investment is required as the sales increase in the following years. In years 3 and 4, no additional investment is required in working capital as the sales decrease in the following years. All the working capital is assumed to be recovered at the end of year 5

operating cash flow (OCF) each year = income after tax + depreciation - additional working capital required

Book value of equipment at end of year 5 = installed cost - accumulated depreciation

There is a loss on salvage value since the sale price is less than book value. This results in a tax benefit since the loss is deductible for tax purposes

Cash flow in year 5 = OCF + terminal cash flow

terminal cash flow = after tax salvage value + recovery of working capital

NPV and IRR are calculated using NPV and IRR functions in Excel

NPV is $12,519,653.80

IRR is 40.76%