Question

Sanders Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $288,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $123,000, 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 $48,000, 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 40 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

Depreciation of equipment = (Initial cost –Salvage value)/Useful life

                                                  = $ 288,000/7 = $ 41,142.86

Computations of annual revenue and expenses:

	Year
	1	2	3	4	5	6	7
Annual revenue	$123,000	$123,000 x 1.04	$127,920 x1.04	$133,036.80 x 1.04	$138,358.27 x1.04	$143,892.60 x 1.04	$149,648.31 x 1.04
		=$127,920	=$133,036.80	=$138,358.27	=$143,892.60	=$149,648.31	=$155,634.24
Annual expenses	$48,000	$48,000 x 1.05	$50,400 x 1.05	$52,920 x 1.05	$55,566 x 1.05	$58,344.30 x 1.05	$61,261.52 x 1.05
		=$50,400	=$52,920	=$55,566.00	=$58,344.30	=$61,261.52	=$64,324.59

Computations of annual cash flow:

	Year
	1	2	3	4	5	6	7
Revenue	$123,000.00	$127,920.00	$133,036.80	$138,358.27	$143,892.60	$149,648.31	$155,634.24
Less: Production cost	$48,000.00	$50,400.00	$52,920.00	$55,566.00	$58,344.30	$61,261.52	$64,324.59
Less: Depreciation	$41,142.86	$41,142.86	$41,142.86	$41,142.86	$41,142.86	$41,142.86	$41,142.86
EBIT	$33,857.14	$36,377.14	$38,973.94	$41,649.41	$44,405.45	$47,243.93	$50,166.79
Less: Tax @ 40%	$13,542.86	$14,550.86	$15,589.58	$16,659.77	$17,762.18	$18,897.57	$20,066.72
Net income	$20,314.29	$21,826.29	$23,384.37	$24,989.65	$26,643.27	$28,346.36	$30,100.07
Add: Depreciation	$41,142.86	$41,142.86	$41,142.86	$41,142.86	$41,142.86	$41,142.86	$41,142.86
Cash Flow	$61,457.14	$62,969.14	$64,527.22	$66,132.51	$67,786.12	$69,489.22	$71,242.93

Computation of NPV:

Year	Cash Flow (C)	PV Factor calculation	PV Factor @ 7 % (F)	PV (= C x F)
0	($288,000)	1/(1+7%)^0	1	($288,000.00)
1	$61,457.14	1/(1+7%)^1	0.934579439	$57,436.58
2	$62,969.14	1/(1+7%)^2	0.873438728	$54,999.69
3	$64,527.22	1/(1+7%)^3	0.816297877	$52,673.44
4	$66,133.51	1/(1+7%)^4	0.762895212	$50,452.17
5	$67,786.12	1/(1+7%)^5	0.712986179	$48,330.57
6	$69,489.22	1/(1+7%)^6	0.666342224	$46,303.60
7	$71,243.93	1/(1+7%)^7	0.622749742	$44,366.52
			NPV	$66,562.56