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Q1. Carla is considering a project where the Units will be constant, but the sales price...
Q1. Carla is considering a project where the Units will be constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs will rise with inflation. The project should last for 3 years. Straight line depreciation method would be used and there will be no salvage value. No change in net operating working capital would be required. What is the difference in the expected NPV before and after inflation? Kindly show working and formula on every step?
Equipment cost $250,000
Units sold 60,000
Price per unit $25.00
Fixed costs $150,000
Variable cost/unit $20
Depreciation rate 33.33%
Expected inflation 4.00%
Tax rate 40.0%
WACC 10.0%
Solutions
Expert Solution
Ans.
NPV before Inflation
| A/1 | B | C | D | E | F |
| 2 | Year 0 | Year 0 | Year 1 | Year 2 | Year 3 |
| 3 | Initial investment | $ (250,000.00) | |||
| 4 | Sales revenue | $ 1,500,000.00 | $ 1,500,000.00 | $ 1,500,000.00 | |
| 5 | Less: Variable cost | $ 1,200,000.00 | $ 1,200,000.00 | $ 1,200,000.00 | |
| 6 | Less: Fixed costs other than dep | $ 150,000.00 | $ 150,000.00 | $ 150,000.00 | |
| 7 | Less: Depreciation | $ 83,325.00 | $ 83,325.00 | $ 83,325.00 | |
| 8 | Profit before tax | $ 66,675.00 | $ 66,675.00 | $ 66,675.00 | |
| 9 | Less tax@40% | $ 26,670.00 | $ 26,670.00 | $ 26,670.00 | |
| 10 | Profit after tax | $ 40,005.00 | $ 40,005.00 | $ 40,005.00 | |
| 11 | Add: Depreciation | $ 83,325.00 | $ 83,325.00 | $ 83,325.00 | |
| 12 | Cash inflow after tax | $ 123,330.00 | $ 123,330.00 | $ 123,330.00 | |
| 13 | Total cash flows | $ (250,000.00) | $ 123,330.00 | $ 123,330.00 | $ 123,330.00 |
| 14 | Discounting Factor @ 10% | 1 | 0.909090909 | 0.826446281 | 0.751314801 |
| 15 | Present Value | $ (250,000.00) | $ 112,118.18 | $ 101,925.62 | $ 92,659.65 |
| 16 | Net Present Value | $ 56,703.46 |
Formulas
| A/1 | B | C | D | E | F |
| 2 | Year 0 | Year 0 | Year 1 | Year 2 | Year 3 |
| 3 | Initial investment | -250000 | |||
| 4 | Sales revenue | =60000*25 | =60000*25 | =60000*25 | |
| 5 | Less: Variable cost | =60000*20 | =60000*20 | =60000*20 | |
| 6 | Less: Fixed costs other than dep | 150000 | 150000 | 150000 | |
| 7 | Less: Depreciation | =250000*33.33% | =250000*33.33% | =250000*33.33% | |
| 8 | Profit before tax | =+D4-D5-D6-D7 | =+E4-E5-E6-E7 | =+F4-F5-F6-F7 | |
| 9 | Less tax@40% | =+D8*40% | =+E8*40% | =+F8*40% | |
| 10 | Profit after tax | =+D8-D9 | =+E8-E9 | =+F8-F9 | |
| 11 | Add: Depreciation | =+D7 | =+E7 | =+F7 | |
| 12 | Cash inflow after tax | =+D10+D11 | =+E10+E11 | =+F10+F11 | |
| 13 | Total cash flows | =SUM(C3:C12) | =+D12 | =+E12 | =+F12 |
| 14 | Discounting Factor @ 10% | 1 | =+C14/1.1 | =+D14/1.1 | =+E14/1.1 |
| 15 | Present Value | =+C13*C14 | =+D13*D14 | =+E13*E14 | =+F13*F14 |
| 16 | Net Present Value | =+C15+D15+E15+F15 |
NPV after Inflation
| A/1 | B | C | D | E | F |
| 2 | Year 0 | Year 0 | Year 1 | Year 2 | Year 3 |
| 3 | Initial investment | $ (250,000.00) | |||
| 4 | Sales revenue | $ 1,500,000.00 | $ 1,560,000.00 | $ 1,622,400.00 | |
| 5 | Less: Variable cost | $ 1,200,000.00 | $ 1,248,000.00 | $ 1,297,920.00 | |
| 6 | Less: Fixed costs other than dep | $ 150,000.00 | $ 150,000.00 | $ 150,000.00 | |
| 7 | Less: Depreciation | $ 83,325.00 | $ 83,325.00 | $ 83,325.00 | |
| 8 | Profit before tax | $ 66,675.00 | $ 78,675.00 | $ 91,155.00 | |
| 9 | Less tax@40% | $ 26,670.00 | $ 31,470.00 | $ 36,462.00 | |
| 10 | Profit after tax | $ 40,005.00 | $ 47,205.00 | $ 54,693.00 | |
| 11 | Add: Depreciation | $ 83,325.00 | $ 83,325.00 | $ 83,325.00 | |
| 12 | Cash inflow after tax | $ 123,330.00 | $ 130,530.00 | $ 138,018.00 | |
| 13 | Total cash flows | $ (250,000.00) | $ 123,330.00 | $ 130,530.00 | $ 138,018.00 |
| 14 | Discounting Factor @ 10% | 1 | 0.909090909 | 0.826446281 | 0.751314801 |
| 15 | Present Value | $ (250,000.00) | $ 112,118.18 | $ 107,876.03 | $ 103,694.97 |
| 16 | Net Present Value | $ 73,689.18 |
Formulas
| A/1 | B | C | D | E | F |
| 2 | Year 0 | Year 0 | Year 1 | Year 2 | Year 3 |
| 3 | Initial investment | -250000 | |||
| 4 | Sales revenue | =60000*25 | =60000*26 |
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