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Problem 10-32 Project Evaluation [LO1] Aria Acoustics, Inc. (AAI), projects unit sales for a new seven-octave...

Problem 10-32 Project Evaluation [LO1]

Aria Acoustics, Inc. (AAI), projects unit sales for a new seven-octave voice emulation implant as follows:

Year Unit Sales
1 75,000
2 88,000
3 102,000
4 97,000
5 78,000

Production of the implants will require $1,540,000 in net working capital to start and additional net working capital investments each year equal to 10 percent of the projected sales increase for the following year. Total fixed costs are $1,440,000 per year, variable production costs are $235 per unit, and the units are priced at $350 each. The equipment needed to begin production has an installed cost of $20,400,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS property. In five years, this equipment can be sold for about 15 percent of its acquisition cost. AAI is in the 30 percent marginal tax bracket and has a required return on all its projects of 17 percent. (MACRS schedule)

What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  NPV $   

What is the IRR? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  IRR $   

Solutions

Expert Solution

Present Value (PV) of Cash flow=(Cash flow)/((1+i)^N)
i=Discount rate=Required rate of return=17%=0.17
N=Year of Cash flow
Year wise cash flows are given below:
Net Working Capital investment in year 1 $        455,000 (0.1*(3080000-26250000)
Net Working Capital investment in year N (0.1*(Sales revenue (Year N+1)-Sales Revenue (Year N))
N Year 0 1 2 3 4 5
A Unit sales 75000 88000 102000 97000 78000
B Initial Net Working Capital ($1,540,000)
C=350*A Sales Revenue $        26,250,000 $        30,800,000 $        35,700,000 $        33,950,000 $        27,300,000
Net Working Capital investment $              455,000 $              490,000 $            (175,000) $            (665,000)
D Cash flow due to Net Working Capital change ($1,540,000) $            (455,000) $            (490,000) $              175,000 $              665,000 $          1,645,000
E Fixed cost $1,440,000 $1,440,000 $1,440,000 $1,440,000 $1,440,000
F=A*235 Variable Cost $        17,625,000 $        20,680,000 $        23,970,000 $        22,795,000 $        18,330,000
G=C-E-F Before tax cash flow from operations $          7,185,000 $          8,680,000 $        10,290,000 $          9,715,000 $          7,530,000
H=G*(1-0.3) After tax cash flow from operations $          5,029,500 $          6,076,000 $          7,203,000 $          6,800,500 $          5,271,000 Sum
I Installed cost of Equipment ($20,400,000)
J 7 year MACRS Depreciation rate 14.29% 24.49% 17.49% 12.49% 8.93% 77.69%
K=20400000*J MACRS Depreciation amount $          2,915,160 $          4,995,960 $          3,567,960 $          2,547,960 $          1,821,720 $ 15,848,760
X Accumulated Depreciation $          2,915,160 $          7,911,120 $        11,479,080 $        14,027,040 $        15,848,760
L=K*0.3 Depreciation Tax Shield $              874,548 $          1,498,788 $          1,070,388 $              764,388 $              546,516
M=0.15*20400000 Salvage Value at end of 5 years $3,060,000
N=D+H+I+L+M NET CASH FLOW ($21,940,000) $          5,449,048 $          7,084,788 $          8,448,388 $          8,229,888 $        10,522,516 SUM
PV=N/(1.17^N) Present Value (PV) of Net Cash Flow ($21,940,000) 4657305.983 5175533.64 5274924.717 4391880.128 4799436.898 $2,359,081
Net Present Value(NPV)=Sum of PV of Cash flows
NPV $2,359,081
IRR (Internal Rate of Return) 21.13% ( Using IRR Function of excel over cash flows)



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