Question

United Pigpen is considering a proposal to manufacture high-protein hog feed. The project would make use of an existing warehouse, which is currently rented out to a neighboring firm. The next year’s rental charge on the warehouse is $160,000, and thereafter, the rent is expected to grow in line with inflation at 4% a year. In addition to using the warehouse, the proposal envisages an investment in plant and equipment of $1.56 million. This could be depreciated for tax purposes straight-line over 10 years. However, Pigpen expects to terminate the project at the end of 8 years and to resell the plant and equipment in year 8 for $520,000. Finally, the project requires an immediate investment in working capital of $410,000. Thereafter, working capital is forecasted to be 10% of sales in each of years 1 through 7. Year 1 sales of hog feed are expected to be $5.40 million, and thereafter, sales are forecasted to grow by 5% a year, slightly faster than the inflation rate. Manufacturing costs are expected to be 90% of sales, and profits are subject to tax at 21%. The cost of capital is 12%.

What is the NPV of Pigpen’s project?

Answer 1

Calculation of NPV
Years	0	1	2	3	4	5	6	7	8
Sale Amount		$    5,400,000.00	$ 5,670,000.00	$ 5,953,500.00	$ 6,251,175.00	$ 6,563,733.75	$ 6,891,920.44	$ 7,236,516.46	$ 7,598,342.28
Expenses		$    4,860,000.00	$ 5,103,000.00	$ 5,358,150.00	$ 5,626,057.50	$ 5,907,360.38	$ 6,202,728.39	$ 6,512,864.81	$ 6,838,508.05
Rent		$        160,000.00	$      166,400.00	$      173,056.00	$      179,978.24	$      187,177.37	$      194,664.46	$      202,451.04	$      210,549.08
Depreciation		$        156,000.00	$      156,000.00	$      156,000.00	$      156,000.00	$      156,000.00	$      156,000.00	$      156,000.00	$      156,000.00
Profit Before Tax		$        224,000.00	$      244,600.00	$      266,294.00	$      289,139.26	$      313,196.01	$      338,527.58	$      365,200.60	$      393,285.14
Tax @ 21 %		$          47,040.00	$        51,366.00	$        55,921.74	$        60,719.24	$        65,771.16	$        71,090.79	$        76,692.13	$        82,589.88
Profit After Tax		$        176,960.00	$      193,234.00	$      210,372.26	$      228,420.02	$      247,424.84	$      267,436.79	$      288,508.48	$      310,695.26
Depreciation		$        156,000.00	$      156,000.00	$      156,000.00	$      156,000.00	$      156,000.00	$      156,000.00	$      156,000.00	$      156,000.00
Cash Flow After Tax		$        332,960.00	$      349,234.00	$      366,372.26	$      384,420.02	$      403,424.84	$      423,436.79	$      444,508.48	$      466,695.26
Working Capital	$       410,000.00	$        540,000.00	$      567,000.00	$      595,350.00	$      625,117.50	$      656,373.38	$      689,192.04	$      723,651.65	$                       -
Change In WC	$     (410,000.00)	$      (130,000.00)	$      (27,000.00)	$      (28,350.00)	$      (29,767.50)	$      (31,255.88)	$      (32,818.67)	$      (34,459.60)	$      723,651.65
Capital Cashflow	$ (1,560,000.00)	0	0	0	0	0	0	0	$      476,320.00
Net Cashflow	$ (1,970,000.00)	$        202,960.00	$      322,234.00	$      338,022.26	$      354,652.52	$      372,168.97	$      390,618.12	$      410,048.87	$ 1,666,666.91
PV of Cashflow @ 12%	$ (1,970,000.00)	$        181,214.29	$      256,882.97	$      240,597.57	$      225,388.09	$      211,178.67	$      197,899.30	$      185,485.29	$      673,138.81
NPV	$       201,784.97

Calculation Of Salavage Value
Initital Invetment		$    1,560,000.00
Accumlated Dep		$    1,248,000.00
Book Value		$       312,000.00
Sale Value		$       520,000.00
Tax Amt		$          43,680.00
After Tax Salvage		$       476,320.00