Question

Cliff’s Canister Corp. (CCC) makes industrial canisters for the petro-chemical industry and is considering building a new plant. CCC has existing land for the plant that they paid $120,000 three years ago, but believe they believe they can only sell for $100,000 today. The new plant will require investing $400,000 in new equipment. The equipment will be depreciated to zero over the 4-year life of the project and the equipment will have a salvage value of $100,000 at the end of the project. Additionally, the new plant will require an additional investment in inventory of $20,000. CCC just finished a $40,000 environmental impact study for the proposed factory. If they build the new factory, CCC believes it can sell 1,000 new canisters every year over the 4 year life of the project. The canisters have a sales price of $200 each and a variable cost of $60 each. CCC’s cost of capital (discount rate) is 15% and their tax rate is 30%.

What is the IRR of the project?

What is the NPV of the project (round to the nearest dollar)?

Should CCC accept the new project?

Answer 1

NPV of the Project (@ 15% Discount Rate)	$       7365
IRR of the Project (Makes NPV = 0)	14.22%
Do Not Accept this Project because it gives a negative NPV. Accepting this project will erode Shareholder's wealth.

Note: the Cost of Land and environmental impact study is a sunk cost and is irrelevant to the decision making.

	0	1	2	3	4
Units Sold	$                        -	$         1,000.00	$       1,000.00	$       1,000.00	$         1,000.00
Projected Sales Revenue ($200/Unit)		$    200,000.00	$ 200,000.00	$ 200,000.00	$    200,000.00
Variable Cost ($60/Unit)		$    (60,000.00)	$ (60,000.00)	$ (60,000.00)	$    (60,000.00)
Depreciation (400000 -100000)/4		$    (75,000.00)	$ (75,000.00)	$ (75,000.00)	$    (75,000.00)
EBIT		$      65,000.00	$    65,000.00	$    65,000.00	$      65,000.00
Tax @ 30%		$    (19,500.00)	$ (19,500.00)	$ (19,500.00)	$    (19,500.00)
Net Income		$      45,500.00	$    45,500.00	$    45,500.00	$      45,500.00
Add back Depreciation		$       75,000.00	$    75,000.00	$    75,000.00	$       75,000.00
Cash Flows from Operations	$                       -	$    120,500.00	$ 120,500.00	$ 120,500.00	$    120,500.00
Initial Investment	$    (400,000.00)				$    100,000.00
Investment in Inventory (Working Capital)	$      (20,000.00)				$       20,000.00
Total Cash Flows	$    (420,000.00)	$    120,500.00	$ 120,500.00	$ 120,500.00	$    240,500.00
Discount Factor @ 15% (Cost of Capital)	1	0.870	0.756	0.658	0.572
Present Values	$    (420,000.00)	$    104,782.61	$    91,115.31	$    79,230.71	$    137,506.66
Net Present Value (Sum of all Present Values)	$        (7,364.72)	1.15