Question

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the demand for a new line of solar-charged motorcycles​ (who wants to ride on a cloudy day​ anyway?) The proposed project has the following​ features; ​• The firm just spent​ $300,000 for a marketing study to determine consumer demand​ (@ t=0). ​• Aero Motorcycles purchased the land the factory will be built on 5 years ago for​ $2,000,000 and owns it outright​ (that is, it does not have a​ mortgage).

The land has a current market value of​ $2,913,027. ​• The project has an initial cost of​ $20,000,000 (excluding​ land, hint: the land is not subject to​ depreciation). ​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​ $3,500,000, accounts receivable by​ $1,500,000, and its accounts payable by​ $2,000,000. This net operating working capital will be recovered at the end of the​ project’s life​ (t =​ 10). ​• If the project is​ undertaken, the company will realize an additional​ $8,000,000 in sales over each of the next ten years.​ (i.e. sales in each year are​ $8,000,000) ​• The company’s operating cost​ (not including​ depreciation) will equal​ 50% of sales. ​•

The company’s tax rate is 35 percent. ​• Use a​ 10-year straight-line depreciation schedule. ​• At t​ = 10, the project is expected to cease being economically viable and the factory​ (including land) will be sold for $4,500,000 (assume land has a book value equal to the original purchase​ price). ​• The project’s WACC​ = 10 percent ​• Assume the firm is profitable and able to use any tax credits​ (i.e. negative​ taxes). What is the​ project's NPV? Round to nearest whole dollar value.

Answer 1

The Project's NPV = -$3,081,731

Since the NPV is negative, the project should not be undertaken.

Note:

1. Marketing Study cost of $300,000 has been already incurred (sunk cost) and does not impact or influence the future cash-flows of the project. Hence this cost is not a relevant cost and is not considered for NPV calculations.

2. Cost of land 5 years ago of $2,000,000. has been already incurred (sunk cost) and does not impact or influence the future cash-flows of the project. Hence this cost is not a relevant cost and is not considered for NPV calculations. However, for calculting the profit on sale at the end of 10th year, this value is considered as book value of land to determine the tax impact.

3. Current Market Value of land of $2,913,027 is a relevant cost and is considered as an opportunity cost and hence been added to cash-outflow in Year 0. This is because if the project is not undertaken, the land can be sold at this value which is a cash-inflow and because the project is undertaken, the opportunity to sell the land is lost and hence it is a opportunity cost.

4. Increase in inventory and accounts receivable are cash-outflows and increase in accounts payable is an cash-inflow.

5. Since the depreciation is straight-line to ten years, the initial cost of $20,000,000 is fully depreciated by 10th year and hence the book value of the factory is zero.