Question

Rockland Co is considering purchasing gear to increase its business. Given the information below, conduct the required capital budgeting analysis to offer a recommendation. Use five of the following seven methods. Please detail any assumptions made and show your calculations for your recommendation. Finally, calculate DeltaNPV/DeltaPrice.

• Net Present Value
• Internal Rate of Return
• Modified Internal Rate of Return
• Profitability Index
• Payback Period
• Discounted Payback Period
• Average Accounting Return

To purchase the equipment, Rockland Co. incurs the following costs:

Equipment purchase price	$35,700,000
Equipment useful life	5 years, Straight Line Depreciation Rate 20% per year
Equipment Salvage value	$4,670,000
Required R&D	$1,200,000
Marketing study	$450,000

Rockland Co wants to produce a unique widget with the following cost structure:

Unit Price	$525
Unit Variable Cost	$310
Fixed Cost	$6,200,000
Tax Rate	30%
Estimate of the Annual Net Working Capital of Sales	25%
Required Return	15%

The company’s projections for sales are shown below:

Year	1	2	3	4	5
Sales (units)	75,000	98,000	115,000	105,000	65,000

Answer 1

Formula	Year (n)	0	1	2	3	4	5
Equipment purchase price	Initial investment (II)	35700000
	Units sold (u)		75000.00	98000	115000	105000	65000
	Price per unit (p)		525.00	525.00	525.00	525.00	525.00
	Cost per unit ('c)		310.00	310.00	310.00	310.00	310.00
u*p	Sales (S)		39375000	51450000	60375000	55125000	34125000
	Fixed costs (FC)		6200000	6200000	6200000	6200000	6200000
u*c	Total variable cost (VC)		23250000	30380000	35650000	32550000	20150000
II/5	Depreciation (D)		7140000	7140000	7140000	7140000	7140000
S-FC-VC-D	EBIT		2785000	7730000	11385000	9235000	635000
30%*EBIT	Tax @ 30%		835500	2319000	3415500	2770500	190500
EBIT-Tax	Net income (NI)		1949500	5411000	7969500	6464500	444500
	Add: Depreciation (D)		7140000	7140000	7140000	7140000	7140000
NI+D	Operating Cash Flow (OCF)		9089500	12551000	15109500	13604500	7584500
25%*S	NWC		9843750	12862500	15093750	13781250	8531250
NWCn-1 - NWCn	Increase in NWC		-9843750	-3018750	-2231250	1312500	13781250
	Sale price (sp)						4670000
sp*(1-Tax rate)	After-tax salvage value (SV)						3269000
OCF+SV-II	Free Cash Flow (FCF)	-35700000	-754250	9532250	12878250	14917000	24634750
1/(1+15%)^n	Discount factor @ 15%	1.000	0.870	0.756	0.658	0.572	0.497
FCF*Discount factor	PV of FCF	-35700000	-655870	7207750	8467658	8528843	12247825
Sum of all PVs	NPV	96207.07
Using IRR function with FCFs	IRR	15.08%
Using MIRR function with FCFs & discount rate of 15%	MIRR	15.06%
Sum of (PV1 to PV5)/-PV0	Profitability index (PI)	1.0027

Payback period calculation:

Formula	Year (n)	0	1	2	3	4	5
	Free Cash Flow (FCF)	-35700000	-754250	9532250	12878250	14917000	24634750
CCFn-1 + FCFn	Cumulative cash flow (CCF)	-35700000	-36454250	-26922000	-14043750	873250	25508000
(-CCF3/FCF4)+3	Payback period (in years)	3.94

Note: R&D cost and marketing study are sunk costs so will not be included in the cash flows.

Change in NPV/Change in price:

when price per unit = 525, NPV = 96,207.07

Now, in the NPV table above, change price to 520 per unit. Then NPV = -934,456.66

Change in NPV to change in price = (-934,456.66 -96,207.07)/(520-525) = 206,132.75