Question

Equipment:

The project involves the purchase of a new machine. The machine costs $500,000 is depreciable over 5 years. The machine requires a new building which would cost another $250,000 (we assume that the construction of the building takes place at t=0). The building is also depreciable over 5 years. The building will occupy a field bought 2 years ago for $200,000. The best other use for the field is as a parking lot for employees. The post-tax present value of employee parking for the life of the project is $65,000. In spite of the fact that the building and the machine will be fully depreciated, the company is expected to sell the machine and the building to a competitor for a total salvage value of $200,000 after the 5 year project is complete.

Project Operation:

At the beginning of year 1, the firm will need to increase its noncash working capital by $600,000, fully recovered at the end of the project in five years. The expected quantities of the new product sold to customers would be: Year 1 (ie: at t=1) 400 units; Year 2: 400 units; Year 3: 400 units; Year 4 and 5: 700 units. The sale price of the product is expected to be $1,000 during the first three years and then to grow by 10% each year. The “per unit cost” is expected to be $300 for the duration of the project.

      Other:

      The tax rate is 35%. The discount rate is 10.5%.

Answer 1

Statement showing NPV

Particulars	0	1	2	3	4	5	NPV
Cost of machine	-500000
Construction of building	-250000
Post tax value of employee parking lot	-65000
Increase in WC	-600000
SPPU		1000	1000	1000	1100	1210
VCPU		300	300	300	300	300
CPU		700	700	700	800	910
Units		400	400	400	700	700
Total contribution		280000	280000	280000	560000	637000
Depreciation((500000+250000)/5)		150000	150000	150000	150000	150000
PBT		130000	130000	130000	410000	487000
Tax @ 35%		45500	45500	45500	143500	170450
PAT		84500	84500	84500	266500	316550
Add: depreciation		150000	150000	150000	150000	150000
Annual cash flow		234500	234500	234500	416500	466550
Release of WC						600000
Salvage value(200000*0.65)						130000
Total cash flow	-1415000	234500	234500	234500	416500	1196550
PVIF @ 10.5%	1	0.9050	0.8190	0.7412	0.6707	0.6070
Present value	-1415000	212217	192052	173802	279361	726306	168738