Question

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%?

Answer 1

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.