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ABC Co. has recently completed a $200,000, two-year marketing study. Based on the results of the...

ABC Co. has recently completed a $200,000, two-year marketing study. Based on the results of the study, Datum has estimated that 5,000 units of its new electro-optical data scanner could be sold annually over the next 5 years, at a price of $5,000 each. Variable costs per unit are $4,000, and fixed costs total $5 million per year. Start-up costs include $15 million to build production facilities, and $4 million in net working capital. The $15 million facility will be depreciated on a straight-line basis to a value of zero over the five-year life of the project. At the end of the project’s life, the production facilities will be sold for an estimated $3 million. Finally, start-up would also entail tax-deductible expenses of $75,000 at year zero. Datum is an ongoing, profitable business and pays taxes at a 35% rate on all income and capital gains. Datum has a 20% cost of capital for projects such as this one. Evaluate the project using NPV. ( Each and every step of calculation required.)

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Expert Solution

ABC Co
The $200,000 Markerting study cost is sunk coas as it is already incurred and will not change wheteher the project is pursued
or not. So this is not relevant cost for evaluation.
All Amt in $
Cash Flow and NPV Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Initial Investment
Production Facilities        (15,000,000)
Net working capital          (4,000,000)
Tax deductible expense                (75,000)
Add : Tax shield on Tax deductible expense=75000*35%=                 26,250
a Total Investment in Initial Cash Outflow        (19,048,750)
Cash Flow from Operations
Sales Revenue for 5000 units @$5000 each       25,000,000              25,000,000              25,000,000        25,000,000       25,000,000
Less Variable cost @$4000/unit       20,000,000              20,000,000              20,000,000        20,000,000       20,000,000
depreciation         3,000,000                3,000,000                3,000,000           3,000,000         3,000,000
Fixed cost         5,000,000                5,000,000                5,000,000           5,000,000         5,000,000
EBT        (3,000,000)              (3,000,000)              (3,000,000)         (3,000,000)       (3,000,000)
Tax @35%        (1,050,000)              (1,050,000)              (1,050,000)         (1,050,000)       (1,050,000)
Income After Tax        (1,950,000)              (1,950,000)              (1,950,000)         (1,950,000)       (1,950,000)
Add Back depreciation         3,000,000                3,000,000                3,000,000           3,000,000         3,000,000
b Cash flow from operations         1,050,000                1,050,000                1,050,000           1,050,000         1,050,000
Terminal cash flows
Return of Working capital         4,000,000
After Tax salvage value=$3M*0.65=         1,950,000
c Total Terminal Cash flow         5,950,000
d Total Cash flow =a+b+c=        (19,048,750)         1,050,000                1,050,000                1,050,000           1,050,000         7,000,000
e PV discount factor @20% =1/1.2^n                           1               0.8333                     0.6944                     0.5787                0.4823              0.4019
f PV of Cash flows=d*e        (19,048,750)             874,965                   729,120                   607,635              506,415         2,813,300
NPV =Sum of PV of cash flows=        (13,517,315)
So NPV of the Start up project is = $   (13,517,315)

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