Question

With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital, they decided to focus on surf print table and floor lamps to accent people’s homes. They projected unit sales of these lamps to be 8,300 in the first year, with growth of 4 percent each year for the next five years. Production of these lamps will require $48,000 in net working capital to start. The net working capital will be recovered at the end of the project. Total fixed costs are $108,000 per year, variable production costs are $16 per unit, and the units are priced at $44 each. The equipment needed to begin production will cost $188,000. The equipment will be depreciated using the straight-line method over a five-year life and is not expected to have a salvage value. The effective tax rate is 39 percent and the required rate of return is 25 percent.

What is the NPV of this project?

Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-188000
Initial working capital		-48000
=Initial Investment outlay		-236000
								100.00%
Unit sales			8300	8632	8977.28	9336.3712	9709.826
Profits	=no. of units sold * (sales price - variable cost)		232400	241696	251363.84	261418.39	271875.13
Fixed cost			-108000	-108000	-108000	-108000	-108000
-Depreciation	Cost of equipment/no. of years		-37600	-37600	-37600	-37600	-37600	0	=Salvage Value
=Pretax cash flows			86800	96096	105763.84	115818.39	126275.13
-taxes	=(Pretax cash flows)*(1-tax)		52948	58618.56	64515.9424	70649.22	77027.829
+Depreciation			37600	37600	37600	37600	37600
=after tax operating cash flow			90548	96218.56	102115.94	108249.22	114627.83
reversal of working capital							48000
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							48000
Total Cash flow for the period		-236000	90548	96218.56	102115.94	108249.22	162627.83
Discount factor=	(1+discount rate)^corresponding period	1	1.25	1.5625	1.953125	2.4414063	3.0517578
Discounted CF=	Cashflow/discount factor	-236000	72438.4	61579.8784	52283.36128	44338.881	53289.887
NPV=	Sum of discounted CF=	47930.41