Question

United Pigpen is considering a proposal to manufacture high-protein hog feed. The project would make use of an existing warehouse, which is currently rented out to a neighboring firm. The next year’s rental charge on the warehouse is $155,000, and thereafter, the rent is expected to grow in line with inflation at 4% a year. In addition to using the warehouse, the proposal envisages an investment in plant and equipment of $1.53 million. This could be depreciated for tax purposes straight-line over 10 years. However, Pigpen expects to terminate the project at the end of 8 years and to resell the plant and equipment in year 8 for $510,000. Finally, the project requires an immediate investment in working capital of $405,000. Thereafter, working capital is forecasted to be 10% of sales in each of years 1 through 7. Year 1 sales of hog feed are expected to be $5.30 million, and thereafter, sales are forecasted to grow by 5% a year, slightly faster than the inflation rate. Manufacturing costs are expected to be 90% of sales, and profits are subject to tax at 35%. The cost of capital is 12%.

What is the NPV of Pigpen’s project? (Enter your answer in thousands, not in millions, rounded to the nearest dollar.)

Answer 1

Tax rate		35%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Year-6	Year-7	Year-8	Total
Cost		$    1,530,000	$   1,530,000	$    1,530,000	$    1,530,000	$   1,530,000	$       1,530,000	$1,530,000	$1,530,000
Dep Rate (1/10=10%)		10.00%	10.00%	10.00%	10.00%	10.00%	10.00%	10.00%	10.00%
Depreciation	Cost * Dep rate	$       153,000	$      153,000	$       153,000	$       153,000	$      153,000	$          153,000	$   153,000	$   153,000	$1,224,000
Calculation of after-tax salvage value
Cost of machine			$   1,530,000
Depreciation			$   1,224,000
WDV	Cost less accumulated depreciation	$      306,000
Sale price			$      510,000
Profit/(Loss)	Sale price less WDV	$      204,000
Tax	Profit/(Loss)*tax rate	$        71,400
Sale price after-tax	Sale price less tax		$      438,600
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5	Year-6	Year-7	Year-8
Sale		$    5,300,000	$   5,565,000	$    5,843,250	$    6,135,413	$   6,442,183	$       6,764,292	$7,102,507	$7,457,632
Less: Operating Cost @ 90%		$    4,770,000	$   5,008,500	$    5,258,925	$    5,521,871	$   5,797,965	$       6,087,863	$6,392,256	$6,711,869
Contribution		$       530,000	$      556,500	$       584,325	$       613,541	$      644,218	$          676,429	$   710,251	$   745,763
Less: Rental charge		$       155,000	$      161,200	$       167,648	$       174,354	$      181,328	$          188,581	$   196,124	$   203,969
Less: Depreciation		$       153,000	$      153,000	$       153,000	$       153,000	$      153,000	$          153,000	$   153,000	$   153,000
Profit before tax (PBT)		$       222,000	$      242,300	$       263,677	$       286,187	$      309,890	$          334,848	$   361,126	$   388,794
Tax@35%	PBT*Tax rate	$         77,700	$        84,805	$         92,287	$       100,166	$      108,462	$          117,197	$   126,394	$   136,078
Profit After Tax (PAT)	PBT - Tax	$       144,300	$      157,495	$       171,390	$       186,022	$      201,429	$          217,651	$   234,732	$   252,716
Add Depreciation	PAT + Dep	$       153,000	$      153,000	$       153,000	$       153,000	$      153,000	$          153,000	$   153,000	$   153,000
Cash Profit after-tax		$       297,300	$      310,495	$       324,390	$       339,022	$      354,429	$          370,651	$   387,732	$   405,716
Calculation of working capital movement
Working capital-opening	$                      -	$       405,000	$      530,000	$       556,500	$       584,325	$      613,541	$          644,218	$   676,429	$   710,251
Closing working capital	$            405,000	$       530,000	$      556,500	$       584,325	$       613,541	$      644,218	$          676,429	$   710,251	$             -
Movement	$            405,000	$       125,000	$        26,500	$         27,825	$         29,216	$        30,677	$            32,211	$     33,821	$ (710,251)
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