Question

Amazing Manufacturing, Inc., has been considering the purchase of a new manufacturing facility for $500,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value at that time. Operating revenues from the facility are expected to be $390,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 4 percent. Production costs at the end of the first year will be $235,000, in nominal terms, and they are expected to increase at 5 percent per year. The real discount rate is 7 percent. The corporate tax rate is 21 percent.

   

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

Answer 1

Assuming the life of project as 7 years because the asset is fully depreciated over 7 years.

Depreciation = $500,000/7 = $71,428.57

There will be a saving of Tax from the depreciation

Which is = Depreciation multiplied by tax rate

Which is = $71,428.57 * 21% = $15,000

This saving of $15,000 is for through out the life of the project and will be added to cash inflow in the below table.

NPV = Discounted Cash Inflow - Discounted Cash Outflow

Therefore, NPV = $2,427,389.05 - $1,953,810.76 = $473,578.30

Formula for discount factor =

where,

i = discount rate

n = number of periods

Note: Cash Outflow and Inflow at the end of the period is inflated at 5% and 4% respectively.