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Vandelay Industries is evaluating a project that costs $1,350,000 and has a 20 year life. Depreciation...

Vandelay Industries is evaluating a project that costs $1,350,000 and has a 20 year life. Depreciation will be straight-line to zero over the life of the project. Management believes they will be able to sell the equipment at the end of the project for $50,000. Sales are projected to be 50,000 units in the first year, 70,000 units in the second year, and 25,000 units for all additional years. Price per unit is $34.50, variable cost per unit is $15.50 and fixed costs are $300,000 per year. The project also requires an initial investment in net working capital of $150,000 and for the project to maintain a net working capital balance equal to $150,000 plus 15% of sales while the project is ongoing. All net working capital will be recouped at the end of the project. This project will have an additional spillover effect that will impact existing sales negatively. The net pre-tax impact of the spillover effect will be -$75,000 per year. This project will also have a positive spillover effect. Specifically, the project will generate additional sales of 100 units of an existing product at a price of $15 each. The existing product has variable costs of $9 and fixed costs of $5,000 per year. The company’s marginal tax rate is 35%. The required return on similar projects is 11%.

1) What is the project’s NPV?

2) What is the project’s payback period?

3) What is the project’s profitability index?

4) Why might this company decide to pursue this project?

Please show all steps clearly. Thank you.

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Expert Solution

Year Sales Voume Sales Value@(34.5-15.5)=19 Less F.C Negative Spill over Positive Spill over @100(15-9)+5000 p.yr Less: Annual Depreciation Taxable Income Tax @ 35% After tax income Add: Tax shield due to depn. Cash flow Add:NWC@ 15% *Sales Net Annual Cash flow PV F @ 11% PV @ 11% COC
0-Initial Cost -1350000 -1350000 -1350000 -1350000 1 -1350000
0- NWC Introd -150000 -150000 -150000 -150000 1 -150000
1 50000 950000 300000 75000 5600 65000 515600 180460 335140 22750 357890 -142500 215390 0.9009 194044.851
2 70000 1330000 300000 75000 5600 65000 895600 313460 582140 22750 604890 -199500 405390 0.81162 329022.632
3 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.73119 -16166.611
4 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.65873 -14564.52
5 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.59345 -13121.18
6 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.53464 -11820.89
7 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.48166 -10649.503
8 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.43393 -9594.1923
9 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.39092 -8643.2412
10 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.35218 -7786.6998
11 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.31728 -7015.0608
12 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.28584 -6319.9224
13 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.25751 -5693.5461
14 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.23199 -5129.2989
15 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.209 -4620.99
16 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.18829 -4163.0919
17 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.16963 -3750.5193
18 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.15282 -3378.8502
19 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.13768 -3044.1048
20 25000 475000 300000 75000 5600 65000 40600 14210 26390 22750 49140 -71250 -22110 0.12403 -2742.3033
20 sale of Equipment 50000 50000 17500 32500 32500 32500 0.12403 4030.975
Recovery of all WC 150000+1624500(NO TAX) 1774500 1774500 1774500 1774500 1774500 0.12403 220091.235
Net Cash flows &NPV of the project 529800 -891014.83
-1624500
Annual Deprciation
(1350000-50000)/20   =0000000000000000
Alternate Method
Initial investment @ year 0                               -1350000
Initial NWC @ year 0                                                  150000 -150000
PV of year 1 Net cash flow- 215390*0.9009 194044.85 Detaiils as per table
PV of year 2 Net cash flow- 405390*0.81162 329022.63 Detaiils as per table
PV of years (3 to 20) Net cash flow 22110*6.25077 -138204.52 Detaiils as per table
PV of sale value 50000*0.65*0.12403 4030.98
PV of release of NWC 1774500 * 0.12403 220091.24
Net Present Value0 -891014.83
0

NPV OF THE PROJECT IS NEGATIVE

jeff jeffy answered 2 years ago
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