Question

The Bruin's Den Outdoor Gear is considering a new 7-year project to produce a new tent line. The equipment necessary would cost $1.99 million and be depreciated using straight-line depreciation to a book value of zero. At the end of the project, the equipment can be sold for 10 percent of its initial cost. The company believes that it can sell 31,000 tents per year at a price of $79 and variable costs of $38 per tent. The fixed costs will be $545,000 per year. The project will require an initial investment in net working capital of $253,000 that will be recovered at the end of the project. The required rate of return is 12.2 percent and the tax rate is 35 percent. What is the NPV?

Answer 1

NPV of project is $ 519,084.61

Explanation:

Initial cost of equipment = $ 1,990,000

Depreciation = Initial cost of equipment/No. of useful year

                    = $ 1,990,000/7 = $ 284,285.71

Scrap value = 10 % x $ 1,990,000 = $ 199,000

Scrap value after tax = $ 199,000 x (1 - 0.35) =$ 1,990,000 x 0.65 = $ 129,350

Sales revenue = $ 79 x 31,000 = $ 2,449,000

Total variable cost = $ 38 x 31,000 = $ 1,178,000

Computation of annual cash flow:

Sales	$    2,449,000.00
Less: Variable cost	$    1,178,000.00
Contribution margin	$    1,271,000.00
Less: Fixed cost	$        545,000.00
EBITDA	$        726,000.00
Less: Depreciation	$        284,285.71
PBT	$        441,714.29
Less: Tax @ 35 %	$        154,600.00
Net Income	$        287,114.29
Add: Depreciation	$        284,285.71
Annual cash flow	$        571,400.00

Computation of NPV:

Year	Cash Flow (C)	PV Factor calculation	PV Factor @ 12.2 %(F)	PV (= C x F)
0	($2,243,000)	1/(1+12.2%)^0	1	($2,243,000.00)
1	$   571,400	1/(1+12.2%)^1	0.891265597	$509,269.16
2	$   571,400	1/(1+12.2%)^2	0.794354365	$453,894.08
3	$   571,400	1/(1+12.2%)^3	0.707980717	$404,540.18
4	$   571,400	1/(1+12.2%)^4	0.630998857	$360,552.75
5	$   571,400	1/(1+12.2%)^5	0.562387573	$321,348.26
6	$   571,400	1/(1+12.2%)^6	0.501236696	$286,406.65
7	$ 953,750	1/(1+12.2%)^7	0.446735023	$426,073.53
			NPV	$519,084.61

Cash flow for year 0 = Initial cost of equipment + working capital

                                    = $ 1,990,000 + $ 253,000

                                    = $ 2,243,000

Cash flow for year 7 = Annual cash flow + working capital + after tax scrap value

                                   = $ 571,400 + $ 253,000 + $ 129,350

                                   = $ 953,750