In: Finance
You work for Power In Motion Limited (PIM), a company specialized in motion sensor and related products. You are now reviewing information about a new product called U-Power, a kinetic energy generator that a person can wrap around his body to generate power and charge electronic gadgets. You think you should be able to sell $400 million worth of these devices per year for 3 years, starting at the end of this year. Your team has spent $5 million designing and test marketing the products in the past 2 years. Production of the devices will cost $200 million per year (includes both materials and salaries). If you were to launch the production, you will have to buy new equipment worth $80 million. This equipment will have a 4-year life and will be depreciated straight line to zero over that life. You plan to sell the equipment for $25 million at the end of the third year. Your company already had existing net working capital level at $20 million. Production of the new product will require you to increase your working capital from $20 million to $25 million immediately. Working capital will decrease back down to $20 million at the end of the third year. Your tax rate is 40%. What is the NPV of the project if the discount rate is 10%?
Cost of Equipment ($m) | 80 |
Life (Years) | 4 |
Depreciation per year ($m) | 20 |
SP of equipment at the end of 3rd year ($m) | 25 |
Additional working capital requirement ($m) | 5 |
Tax rate | 40% |
Cost of Capital / Discount rate | 10% |
Design and Marketing expense ($m) | 5 |
($m) | ||||
Year | 0 | 1 | 2 | 3 |
Expected Sales (A) | - | 400 | 400 | 400 |
Less: Production cost (B) | - | (200) | (200) | (200) |
Less: Depreciation (C) | - | (20) | (20) | (20) |
Profit before tax (A-B-C) | - | 180 | 180 | 180 |
Less: Tax @ 40% | - | (72) | (72) | (72) |
Net Income | - | 108 | 108 | 108 |
Calculation of cashflow | ||||
Year | 0 | 1 | 2 | 3 |
Net Income | - | 108 | 108 | 108 |
Add: Depreciation | - | 20 | 20 | 20 |
Less: Additional working capital | - | (5) | (5) | (5) |
Less: Cost of equipment | (80) | - | - | - |
Less: Design & marketing exp | (5) | |||
Add sale of equipment | - | - | - | 25 |
Cashflows | (85) | 123 | 123 | 148 |
Discounting factor@ 10% | 1.000 | 0.909 | 0.826 | 0.751 |
Present value of cashflows | (85.00) | 111.82 | 101.65 | 111.19 |
NPV | 239.67 |
Since NPV of the project is positive, hence project is expected to create wealth for shareholders. Hence the project should be accepted.