Question

We assume that the company you selected is considering a new project. The project has 8 years’ life. This project requires initial investment of $380 million to purchase equipment, and $30 million for shipping & installation fee. The fixed assets fall in the 7-year MACRS class. The salvage value of the fixed assets is 10.5% of the purchase price (including the shipping & installation fee). The number of units of the new product expected to be sold in the first year is 1,500,000 and the expected annual growth rate is 5.5%. The sales price is $255 per unit and the variable cost is $190 per unit in the first year, but they should be adjusted accordingly based on the estimated annualized inflation rate of 2.2%. The required net operating working capital (NOWC) is 9.5% of sales. Use the corporate tax rate obtained in Step (4) for the project. The project is assumed to have the same risk as the corporation, so you should use the WACC you obtained from prior steps as the discount rate. Note: you may revise the partial model in the file Ch11 P18 Build a Model.xls on the website of the textbook (also posted in this final project learning module in Blackboard) for capital budgeting analysis, but you are NOT required to strictly follow the partial model. Actually, you are encouraged to build a better model by yourself. - Compute the depreciation basis and annual depreciation of the new project. (You can refer to Table 11A-2 MACRS allowances on pp.496 in the textbook) - Estimate annual cash flows for 8 years. - Draw a time line of the cash flows. WACC = 7.20% Corporate Tax Rate = 18.30%

Answer 1

Calculation of cashflow
		Million $
Initial investment		380
Installation		30
Total Investment		410
	Million
	1	2	3	4	5	6	7	8	Total
Units	1500000	1582500	1669537.5	1761362.063	1858236.976	1960440.01	2068264.2	2182019
Selling price	255	260.61	266.34	272.20	278.19	284.31	290.57	296.96
Sale	382.50	412.42	444.67	479.45	516.95	557.38	600.97	647.97
Variable cost	285.00	307.29	331.32	357.24	385.18	415.30	447.78	482.80
Dep	58.63	100.45	71.75	51.25	36.49	36.49	36.49	18.45
Profit	38.87	4.68	41.60	70.96	95.28	105.59	116.70	146.72
Tax	7.11	0.86	7.61	12.99	17.44	19.32	21.36	26.85
Dep	58.63	100.45	71.75	51.25	36.49	36.49	36.49	18.45
Working Capital	36.338	39.179	42.244	45.548	49.110	52.951	57.092	61.557
Changes in WC	36.34	2.84	3.06	3.30	3.56	3.84	4.14	4.47
Post tax scrap *								35.17
Recovery of WC								61.56
Cashinflow	54.05	101.43	102.67	105.92	110.77	118.91	127.69	230.58
PV @ 7.2%	0.93	0.87	0.81	0.76	0.71	0.66	0.61	0.57
PV of cashinflow	50.42	88.26	83.34	80.21	78.24	78.35	78.49	132.21	669.52
* Scrap value	43.05
Book Value	0
Gain	43.05
Tax	7.87815
Post tax scrap	35.17185
NPV = PV of cashinflow - Initial Investment
	259.52	Million
Project should be acceptable having positive NPV