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 8,500 in the first year, with growth of 7 percent each year for the following four years (Years 2 through 5). Production of these lamps will require $50,000 in networking capital to start. Total fixed costs are $110,000 per year, variable production costs are $22 per unit, and the units are priced at $50 each. The equipment needed to begin production will cost $190,000. The equipment will be depreciated using the straight-line method over a five-year life and is not expected to have a salvage value. The effective tax rate is 40 percent, and the required rate of return is 24 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.)

  

NPV

$

Answer 1

The required rate of return is 24%. Therefore, the future values should be discounted at 24%.

Net working capital requirement at start =$ 50000

Equipment cost at the beginning = $ 190000

Total Initial Investment = 190000 + 50000 = $ 240000

Year 1:

Total sales in 1st year (end of 1st year) = 8500*50 = 425000

Fixed costs = 110000

Variable costs = 8500*22 = 187000

Depreciation = 38000

Profit before tax = 425000-110000-187000-38000 = 90000

Net Cashflow₁ = 90000*0.6 + 38000 = 92000 (Depeciation is added back after deducting tax. Depeciation acts as tax shield)

Present value at starting of the time period = 92000/1.24 = $ 74193.548

Year 2:

Total sales in 2nd year = 8500*1.07*50 = 454750

Fixed costs = 110000

Variable costs = 8500*22*1.07 = 200090

Depreciation = 38000

Profit before tax = 454750-110000-200090-38000 = 106660

Net Casflow₂ = 106660*0.6 + 38000 = 101996

Present value at starting of the time period = 101996/(1.24^2) = $ 66334.547

Year 3:

Total sales in 3rd year = 8500*(1.07^2)*50 = 486582.5

Fixed costs = 110000

Variable costs = 8500*(1.07^2)*22 = 214096.3

Depreciation = 38000

Profit before tax = 486582.5-110000-214096.3-38000 = 124486.2

Net Cashflow₃ = 124486.2*0.6 + 38000 = 112691.72

Present value at starting of the time period = 112691.72/(1.24^3) =$ 59105.371

Year 4:

Total sales in 4th year = 8500*1.07^3*50= 520643.28

Fixed costs = 110000

Variable costs = 8500*22*(1.07^3) = 229083.041

Depreciation = 38000

Profit before tax = 520643.28-110000-229083.041-38000 = 143560.239

Net Cashflow₄ = 143560.239*0.6 + 38000 = 124136.143

Present value at starting of the time period = 124136.143/(1.24^4) = $ 52506.311

Year 5:

Total sales in 5th year = 8500*50*(1.07^4) = 557088.304

Fixed costs = 110000

Variable costs = 8500*22*(1.07^4) = 245118.8539

Depreciation = 38000

Profit before tax = 557088.304-110000-245118.8539-38000 = 163969.45

Net Cashflow₅ = 163969.45*0.6 + 38000 = 136381.67

Present value at starting of the time period = 136381.67/(1.24^5) = $ 46520.843

Present value of Net Cashflows = 74193.548 + 66334.547 + 59105.371 + 52506.311 + 46520.843

= $ 298660.62

NPV of the project = 298660.62 - (total initial investment)

= $ 58660.62