Question

ABCD Inc. manufactures financial calculators. The company is deciding whether to introduce a new calculator. This calculator will sell for $100. The company feels that sales will be 12,500, 13,000, 14,000, 13,200, and 12,500 units per year for the next 5 years. Variable costs will be 25% of sales, and fixed costs are $300,000 per year. The firm hired a marketing team to analyze the viability of the product and the marketing analysis cost $1,500,000. The company plans to use a vacant warehouse to manufacture and store the calculators. Based on a recent appraisal the warehouse and the property is worth $2.5 million on an after-tax basis. If the company does not sell the property today then it will sell the property 5 years from today at the currently appraised value. This project will require an injection of net working capital at the onset of the project in the amount of $100,000. This networking capital will be fully recovered at the end of the project. The firm will need to purchase some equipment in the amount of $1,200,000 to produce the new calculators. The machine has a 7-year life and will be depreciated using the straight-line method. At the end of the project, the anticipated market value of the machine is $150,000. The firm requires a 10% return on its investment and has a tax rate of 21%.

Calculate the book value of the machine at the end of year 5

Calculate the depreciation expense at the end of year 2

Calculate the after tax salvage value at the end of year 5

Calculate the cash flow from assets at the end of year 5

Calculate the net present value for the project

Round to two decimals

Answer 1

the book value of the machine at the end of year 5 = (cost of the machine - accumulated depreciation) = ($1,200,000 - $857,143) = $342,857‬

Yearly depreciation = cost of the machine/life of the machine = $1,200,000/7 = $171,428.5714285714‬

Accumulated depreciation = Yearly depreciation*project's life = $171,428.5714285714‬*5 = $857,143

the depreciation expense at the end of year 2 = $171,428.5714285714‬ or $171,429

the after tax salvage value at the end of year 5 = Sale value - [(sale value - book value)*tax rate] = $150,000 - [($150,000 - $342,857‬)*0.21] =$150,000 - (-192,857*0.21) = $150,000 - (-$40,499.97) = $150,000 + $40,499.97 = $190,499.97 or $190,500

the cash flow from assets at the end of year 5 = $3,330,125

the net present value for the project = $97,868.82

	Years	0	1	2	3	4	5	Total
	Cost of machine	-$1,200,000	0	0	0	0	0	-$1,200,000
	Value of warehouse	-$2,500,000
	Working capital Investment	-$100,000
	Sales quantity	0	12,500	13,000	14,000	13,200	12,500
	Sales price/unit	0	$100.00	$100.00	$100.00	$100.00	$100.00
	Sales	$0	$1,250,000	$1,300,000	$1,400,000	$1,320,000	$1,250,000	$6,520,000
Less:	Variable cost @ 25%	$0	$312,500	$325,000	$350,000	$330,000	$312,500	$1,630,000
Less:	Fixed cost	$0	$300,000	$300,000	$300,000	$300,000	$300,000	$1,500,000
Less:	Depreciation	$0	$171,429	$171,429	$171,429	$171,429	$171,429	$857,143
	Pre-tax cash flow	$0	$466,071	$503,571	$578,571	$518,571	$466,071	$2,532,857
Less:	Taxes @21%	$0	$97,875	$105,750	$121,500	$108,900	$97,875	$531,900
	After-tax cash flow	$0	$368,196	$397,821	$457,071	$409,671	$368,196	$2,000,957
Add back:	Depreciation	$0	$171,429	$171,429	$171,429	$171,429	$171,429	$857,143
Add:	Working capital recovery	$0	$0	$0	$0	$0	$100,000	$100,000
Add:	Selling Value of warehouse	$0	$0	$0	$0	$0	$2,500,000	$2,500,000
Add:	Sale of Machine	$0	$0	$0	$0	$0	$150,000	$150,000
Less:	Tax on equip. sale	$0	$0	$0	$0	$0	-$40,500	-$40,500
	Operating cash flow	-$3,800,000	$539,625	$569,250	$628,500	$581,100	$3,330,125	$1,848,600
	NPV	$97,868.82

Calculations