Question

This case continues following the new project of the WePPROMOTE Company, that you and your partner own. WePROMOTE is in the promotional materials business. The project being considered is to manufacture a unique case for smartphones. The case is very durable, attractive and fits virtually all models of smartphone. It will also have the logo of your client, a prominent, local company and is planned to be given away at public relations events by your client.

As we know from prior cases involving this company, more and more details of the project become apparent and with more precision and certainty.

The following are the final values to the data that you have been estimating up to this point:

- You can borrow funds from your bank at 3%.

- The cost to install the needed equipment will be $105,000 and this cost is incurred prior to any cash is received by the project.

- The gross revenues from the project will be $25,000 for year 1, then $27,000 for years 2 and 3. Year 4 will be $28,000 and year 5 (the last year of the project) will be $23,000.

- The expected annual cash outflows (current project costs) are estimated at being $13,000 for the first year, then $12,000 for years 2, 3, and 4. The final year costs will be $10,000.

- Your tax rate is 30% and you plan to depreciate the equipment on a straight-line basis for the life of the equipment.

- After 5 years the equipment will stop working and will have a residual (salvage) value of $5,000).

- The discount rate you are assuming is now 7%.

The Tasks:

1. Perform the final NPV calculations and provide a narrative of how you calculated the computations and why.

2. Then provide a summary conclusion on whether you should continue to pursue this business opportunity.

Answer 1

1. NPV calculations:

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
A) INCOME STATEMENT
Revenue		25,000	27,000	27,000	28,000	23,000
Less: Outflow of Exp		13,000	12,000	12,000	12,000	10,000
Profit before depreciation and interest		12,000	15,000	15,000	16,000	13,000
*Depreciation		20,000	20,000	20,000	20,000	20,000
^Interest cost		3,150	3,150	3,150	3,150	3,150
Profit before tax		-11,150	-8,150	-8,150	-7,150	-10,150
Tax		0	0	0	0	0
Profit after tax		-11,150	-8,150	-8,150	-7,150	-10,150

*Per year depreciation
Initial Cost	105,000
Less: Residual value	5,000
Depreciable Cost	100,000
Number of years	5
Per year depreciation	20,000

^ Per year Interest cost
Borrowing amount is initial cost of equipment	105,000
Interest rate	3%
Per year interest rate	3,150

B) NPV CALCULATIONS
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Cash flows from Profits (Profit after tax + Depreciation)		8,850	11,850	11,850	12,850	9,850
Purchase of equipment	-105,000
Residual value of equipment received						5,000
Bank Loan taken	105,000
Bank Loan paid						-105,000
Net Cash Flow	0	8,850	11,850	11,850	12,850	-90,150
Discounting Factor at 7%	1	0.93	0.87	0.82	0.76	0.71
Present Value	0	8,271	10,350	9,673	9,803	-64,276
Net Present Value(NPV)	-26,178

Narratives:

We need to calculate the cash flow from the project. For this, we need to calculate net profit of each year of the project.The project has the revenues given for each year and expenses given for each year.

The depreciation for each year is to be calculated by dividing the depreciable amount of the equipment (105,000 of cost - 5,000 as residual value) from the number of years of the asset ie 5 years. This is 20,000 per year

The loan is available for 3%. The entire equipment can be financed by the loan and hence the loan taken is 105,000. Interest amount each on this is 3% of 105,000 ie 3,150.

Since there is no profit before tax, there is no tax and hence profit after tax is also negative ie there is a loss in each year

For the net present value, the cash flows of the project for each year has to be discounted from a discounting rate (in this case 7%).

The cash flow for year 0 is also 0 as the entire outflow of the equipment is done from a loan that is taken. Subsequent years, the cash flows is net profit after tax + depreciation for each year. For the 5th and last year, there is also a cash outflo for repayment of the bank loan of 105,000 and cash inflow of the residual value of the equipment of 5,000.

After discounting all yearly cash flows with their respective discounting factors and then summing them up, we get a net present cashflow of -26,178

2. Since the net present value expected out of this project is a cash outflow of 26,178, we should not pursue this business opportunity.