Question

Otobai Company in Osaka, Japan is considering the introduction of an electrically powered motor scooter for city use. The scooter project requires an initial investment of ¥16.2 billion. The cost of capital is 12%. The initial investment can be depreciated on a straight-line basis over the 10-year life of the project. Profits are taxed at a rate of 50%. Consider the following project estimates: Market size 1.22 million Market share .1 Unit price ¥ 520,000 Unit variable cost ¥ 480,000 Fixed cost ¥ 2.12 billion What is the NPV of the electric scooter project? (A negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in billions rounded to 3 decimal places.) Net present value ¥ billion

Answer 1

Initial investment in the project = Yen16.2 billion

Cost of capital = 12%

Life of the project = 10 Years

Annual depreciation = Initial investment in the project/Life of the project

= 16.2/10

= Yen 1.62 billion

Tax rate = 50%

Total market size = 1.22 million

Market share of Otobai Company = 0.1

Hence, number of scooters to be sold by Otobai Company = 1.22 x 0.1 million

= 0.122 million

Unit price	Yen 520,000
Less:Unit variable cost	-Yen 480,000
Contribution per unit (i)	Yen 40,000
Number of units to be sold (ii)	0.122 million
Total contribution (i) x (ii)	Yen 4.88 billion
Less:Fixed cost	-Yen 2.12 billion
Profit before depreciation	Yen 2.76 billion
Less: Depreciation	-Yen 1.62 billion
Profit before tax	Yen 1.14 billion
Less: Tax @ 50%	-Yen 0.57 billion
Profit after tax	Yen 0.57 billion
Add: Depreciation	Yen 1.62 billion
Cash inflow after tax	Yen 2.19 billion

Present value of cash inflows = Cash inflow after tax x PVAF(_{12%, 10} )

= 2.19 x 5.650

= Yen 12.3735 billion

NPV of the project = Present value of cash inflows - Cost of the project

= 12.3735 - 16.2

= - Yen 3.826 billion

Since NPV of the project is negative, hence it should not be undertaken.