Question

RDH, Inc., manufactures high quality ladies boots. The company is considering the launch of a new boot style. Given the company’s history, it believes that it can sell 34,000, 27,000, 24,000, and 18,000 pair of boots per year for the next 4 years, respectively. The new boots would have variable costs of $134 per pair. Fixed production costs are $4.25 million per year and the equipment necessary for the new line costs $7.8 million. The equipment will be depreciated on a 5-year MACRS schedule. The line would require an investment in NWC of 15 percent of sales to be stockpiled one year ahead of sales, the tax rate is 40 percent, and the required return is 9 percent. The company expects that because of changes in styles, the new design can only be sold for the next four years. In four years, the equipment can be sold for $1.8 million, although the company believes it will keep the machinery for another product line. Additionally, the CEO has stated that she requires an NPV of $250,000 to undertake the new line of boots. What is the price per pair of boots that the company must set in order to undertake the new boot?

Answer 1

Here's The Solution.

If you are attempting this question, You would know how to get Present value factors and calculate basic NPV. But just struggling with the number of items in the question.

So, here is the explanation for different columns,

1. Depreciation: MACRS, straight line for 5 years Base: $7.8 Million is $1.56 Million per year
2. Units: Normal given
3. Sales: Save it for last
4. Variable Cost: Multiply units with $134
5. Fixed Cost: Given
6. Capital Gain: The WDV in last year under MACRS method: 7.8 - (4*15.6) = $15.6 Million and if sold at $1.8 Million, that would result in $240,000 Capital Gain
7. Profit or Loss is Simply, Sales - Depreciation - Variable Cost - Fixed Cost + Capital Gain
8. Tax @ 40% of Profit
9. Operating Cash Flow = Profit + Depreciation - Tax
10. Capital: Normal Given
11. Net Working Capital Flow is 40% of Next Year's Sales considering Existing working capital balance
12. Net Cash Flow: Operating Cash Flow + Capital + NWC
13. Working Capital Balance is exactly 40% of Next Year's Sales

NPV at 9% with Price 0, is $(19,512,768.92)

In excel, you can simply use solver, but if you want to solve, you have to try using present value factors for just Sales, Net working capital Flows to Equal NPV of $19,462,769

PV Factors @ 9% for the four years = 0.9174, 0.8417, 0.7722, 0.7084

The equation to solve would be

Sales=x*60%*(34000*0.9174+27000*0.8417+24000*0.7722+18000*0.7084)

+

Working Capital Flow=x((34000-27000)*0.15*0.9174+(27000-24000)*0.15*0.8417+(24000-18000)*0.15*0.7722+18000*0.15*0.7084)-34000x*0.15

=

19,762,769

==> 49,970.595 X = 19,762,769

==> X = $395.48799665

Good luck