Question

J. Smythe, Inc., manufactures fine furniture. The company is deciding whether to introduce a new mahogany dining room table set. The set will sell for $6,050, including a set of eight chairs. The company feels that sales will be 2,900, 3,050, 3,600, 3,450, and 3,200 sets per year for the next five years, respectively. Variable costs will amount to 45 percent of sales and fixed costs are $1,920,000 per year. The new tables will require inventory amounting to 10 percent of sales, produced and stockpiled in the year prior to sales. It is believed that the addition of the new table will cause a loss of 250 tables per year of the oak tables the company produces. These tables sell for $4,500 and have variable costs of 40 percent of sales. The inventory for this oak table is also 10 percent of sales. The sales of the oak table will continue indefinitely. J. Smythe currently has excess production capacity. If the company buys the necessary equipment today, it will cost $22,000,000. However, the excess production capacity means the company can produce the new table without buying the new equipment. The company controller has said that the current excess capacity will end in two years with current production. This means that if the company uses the current excess capacity for the new table, it will be forced to spend the $22,000,000 in two years to accommodate the increased sales of its current products. In five years, the new equipment will have a market value of $3,100,000 if purchased today, and $7,900,000 if purchased in two years. The equipment is depreciated on a seven-year MACRS schedule. The company has a tax rate of 21 percent and the required return for the project is 15 percent. MACRS schedule Calculate the NPV of new project. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)

NPV:

Answer 1

solution:

New equipment to be purchased in two years = 22000000

selling price 6050

variable cost 45% of sales

fixed cost 1920000

Loss of existing products:

loss of sales of oak tables 250 tables

selling price 4500

variable cost     40% of sales

1.loss of revenue    1125000   

(250*4500)

2.less:variable cost    (450000)   

(40%*1125000)   

3.actual loss of existing product due

to intoduction of new range (1-2) 675000

Note:assuming that excess production capacity will be utilized and new equipment will be purchased after two years

Tax rate = 21%

Required rate of return = 15%

year	depreciation rate%	depreciation
1	14.29	3143800
2	24.49	5387800
3	17.49	3847800
4	12.49	2747800
5	8.93	1964600
6	8.92	1962400
7	8.93	1964600
8	4.46	981200

1.selling price of equipment after five years = 22000000

2.less:book value = (9620600)

( 22000000-3143800-5387800-3847800)

3.Loss on sale (1-2) = 12379400

year	1	2	3	4	5
1.sales in units of new product	2900	3050	3600	3450	3200
2.revenue (1*6050)	17545000	18452500	21780000	20872500	19360000
3.loss of existing sales	675000	675000	675000	675000	675000
4.variable cost (45% *2)	7895250	8303625	9801000	9392625	8712000
5.fixed cost	1920000	1920000	1920000	1920000	1920000
6.depreciation	0	0	3143800	5387800	3847800
7.profit before tax (2-3-4-5-6)	7054750	7553875	6240200	3497075	4205200
8.tax @ 21%	1481497.5	1586313.75	1310442	734385.75	883092
9.profit after tax (7-8)	5573252.5	5967561.25	4929758	2762689.25	3322108
10.depreciation	0	0	3143800	5387800	3847800
11.purchase of equipment after two years			22000000
12.sale of equipment at the end of project					7900000
13.cash flow (9+10-11+12)	5573252.5	5967561.25	-13926442	8150489.25	15069908
14.pv of cash flow = CF / (1+r)n	4846306.52	4512333.64	-9156861.67	4660068.68	7492407.66

net present value = sum of pv of cash flow = 4846306.52+4512333.64-9156861.67+4660068.68+7492407.66

Net present value = 12,354,254.83

-------HOPE THIS IS HELPFUL