Question

You are in charge of deciding whether or not to undertake a new project for your company. The marketing staff believes you can sell 95,000, 145,000, 135,000, 115,000, 98,000, and 75,000 units per year over the next six years, respectively. The variable cost per unit is $21.35. Equipment for production will cost $2.95 million and be depreciated on a five year MACRS schedule over the six-year life of the product. You can sell the equipment for $245,000 at the end of the project. Fixed costs are $1.25 million per year and net working capital equal to 20 percent of next year’s sales is required. The tax rate is 21 percent and the required return is 10 percent. What is the minimum price per unit necessary to accept the project?

*Please show excel formulas with answer*

Answer 1

Statement showing depreciation

Year	Opening balance	Depreciation Rates	Depreciation (purchase price x Depreciation rates)	Closing Balance
1	2950000	20%	590000	2360000
2	2360000	32%	944000	1416000
3	1416000	19.20%	566400	849600
4	849600	11.52%	339840	509760
5	509760	11.52%	339840	169920
6	169920	5.76%	169920	0

Statement showing PV of cash inflow and cash outflow assuming selling price per unit = x

Particulars	0	1	2	3	4	5	6
Cost of Equipment	-2950000
Selling price per unit		x	x	x	x	x	x
Variable cost per unit		21.35	21.35	21.35	21.35	21.35	21.35
Contribution per unit		x-21.35	x-21.35	x-21.35	x-21.35	x-21.35	x-21.35
Units sold		95000	145000	135000	115000	98000	75000
Total contribution		95000x -2028250	145000x - 3095750	135000x -2882250	115000x -2455250	98000x-2092300	75000x -1601250
Less: Fixed cost		1250000	1250000	1250000	1250000	1250000	1250000
Depreciation		590000	944000	566400	339840	339840	169920
PBT		95000x -3868250	145000x -5289750	135000x-4698650	115000x-4045090	98000x-3682140	75000x-3021170
Tax @ 21%		19950x-812332.5	30450x-1110847.5	28350x-986716.50	24150x-849468.9	20580x-773249.4	15750x-634445.7
PAT		75050x-3055917.5	114550x-4178902.5	106650x-3711933.5	90850x-3195621.1	77420x-2908890.6	59250x-2386724.3
Add: Depreciation		590000	944000	566400	339840	339840	169920
Annual cash flow		75050x-2465917.5	114550x-3234902.5	106650x-3145533.5	90850x-2855781.1	77420x-2569050.6	59250x-2216804.3
WC Requirement	-19000x	-29000x	-27000x	-23000x	-19600x	-15000x	132600x
Salvage value of machine [245000 (1-0.21)] [245000(0.79)]							193550
Total cash flow	-19000x -2950000	46050x-2465917.5	87550x-3234902.5	83650x-3145533.5	71250x-2855781.1	62420x-2569050.6	191850x-1996585
PVIF @ 10%	1.00	0.9091	0.8264	0.7513	0.6830	0.6209	0.5645
PV	-19000x -2950000	41863.64x -2241743.18	72355.37x-2673473.14	62847.48x - 2363285.88	48664.71x -1950536.92	38757.91x - 1595178.30	108294.32x - 1127020.18

Thus to find x, PV of cash outflow = PV of cash inflow

=19000x+2950000 = 372783.43x - 11951237.59

=14901237.59 = 353783.43x

x = 42.12$