Question

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the demand for a new line of solar-charged motorcycles​ (who wants to ride on a cloudy day​ anyway?) The proposed project has the following​ features;

​• The firm just spent​ $300,000 for a marketing study to determine consumer demand​ (@ t=0).

​• Aero Motorcycles purchased the land the factory will be built on 5 years ago for​ $2,000,000 and owns it outright​ (that is, it does not have a​ mortgage). The land has a current market value of​ $2,517,803.

​• The project has an initial cost of​ $20,000,000 (excluding​ land, hint: the land is not subject to​ depreciation).

​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​ $3,500,000, accounts receivable by​ $1,500,000, and its accounts payable by​ $2,000,000. This net operating working capital will be recovered at the end of the​ project’s life​ (t =​ 10).

​• If the project is​ undertaken, the company will realize an additional​ $8,000,000 in sales over each of the next ten years.​ (i.e. sales in each year are​ $8,000,000)

​• The company’s operating cost​ (not including​ depreciation) will equal​ 50% of sales.

​• The company’s tax rate is 35 percent.

​• Use a​ 10-year straight-line depreciation schedule.

​• At t​ = 10, the project is expected to cease being economically viable and the factory​ (including land) will be sold for $4,500,000 (assume land has a book value equal to the original purchase​ price).

​• The project’s WACC​ = 10 percent

​• Assume the firm is profitable and able to use any tax credits​ (i.e. negative​ taxes).

What is the​ project's NPV? Round to nearest whole dollar value.

Answer 1

• The firm just spent​ $300,000 for a marketing study to determine consumer demand​ (@ t=0). = It is sunk cost, already spent

.

​• Aero Motorcycles purchased the land the factory will be built on 5 years ago for​ $2,000,000 and owns it outright​ (that is, it does not have a​ mortgage). The land has a current market value of​ $2,517,803.

.

​• The project has an initial cost of​ $20,000,000 (excluding​ land, hint: the land is not subject to​ depreciation).

​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​ $3,500,000, accounts receivable by​ $1,500,000, and its accounts payable by​ $2,000,000. This net operating working capital will be recovered at the end of the​ project’s life​ (t =​ 10).

​• If the project is​ undertaken, the company will realize an additional​ $8,000,000 in sales over each of the next ten years.​ (i.e. sales in each year are​ $8,000,000)

​• The company’s operating cost​ (not including​ depreciation) will equal​ 50% of sales.

​• The company’s tax rate is 35 percent.

​• Use a​ 10-year straight-line depreciation schedule.

​• At t​ = 10, the project is expected to cease being economically viable and the factory​ (including land) will be sold for $4,500,000 (assume land has a book value equal to the original purchase​ price).

​• The project’s WACC​ = 10 percent

.

.

Initial investment = 20000000 + 2,517,803 = 22517803

Net working capital = 3500000 + 1500000 - 2000000 = 3000000

Each year depreciation = 20000000 / 10 = 2000000

.

Additional sale revenue = 8000000 each year

Operating cost = 8000000 * 50% = 4000000 each year

Earning before Tax and depreciation = 8000000 - 4000000 = 4000000

Less: depreciation = 2000000

EBT = 2000000

Tax Exp = 2000000 * 35% = 700000

Net income = 1300000

Add: depreciation = 2000000

Operating cash flow = 1300000 + 2000000 = 3300000 each 10 year

.

Release of working capital = 3000000

Net of tax salvage vale at end =3275000

.

Salvage value = 4500000

Book value of building = 0 (fully depreciated )

Book value of land = 2000000

Gain from sales = 2500000

Tax expenses = 2500000 * 35% = 1225000 (outflow)

Net of tax salvage vale at end = 4500000 - 1225000 = 3275000

.

At end 10 year cash flow = 3300000 + 3000000 + 3275000 =

.

Prepare table

Year	Cash flow	PVIF,10%,n	PV of cash flow
0	-22517803	1	-22517803
1	3300000	0.909091	3000000.3
2	3300000	0.82645	2727285
3	3300000	0.751315	2479339.5
4	3300000	0.68301	2253933
5	3300000	0.62092	2049036
6	3300000	0.56447	1862751
7	3300000	0.51316	1693428
8	3300000	0.46651	1539483
9	3300000	0.42409	1399497
10	9575000	0.38554	3691545.5
NPV		(SUM)	178495.3