Question

Weihu Corporation is considering building a new factory to manufacture bicycles. Weihu has already spent 300,000 in the R&D expense. The new factory will cost $1,500,000. The expected number of bikes produced and sold is 4000 for the first year, 5000 for the second year and 5500 for the third year. The sales price is $250 per bike in the first year in nominal terms. This price is expected to grow at 3% per year in real terms. The variable costs per bike are $120 in the first year in nominal terms. These costs are expected to increase at 2.5% per year in real terms. The factory requires temporary additional personnel, which will result in additional labor costs of $50,000 per year (in nominal terms), which remains constant in real terms. All costs and sales are incurred at the end of each year. Additional net working capital requirements at the beginning of each year are 15% of expected sales for that same year. The market value of the factory after three years is $1,300,000 in real terms. The asset class is closed upon selling the factory. The CCA rate is 4%, the tax rate is 35%, the expected inflation rate is 2.5% and the required rate of return is 10% in real terms. Calculate the project’s NPV.

Answer 1

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R & D expense	300,000
Cost	1,500,000
Inflation	2.50%
Sale value	1,300,000
Required rate of return	10%
rate of return real	12.50%
years	year 1	year 2	year 2	total
No of bicycles produced	4000	5000	5500
Sale price	250	250	263.75
Increase in real terms	0	3%	3%
Total increase	0	5.50%	5.50%
Total Price	250.0	263.8	278.3
Total Sales	1,000,000	1,318,750	1,530,409	3,849,159
Variable Cost	120	120	120
Increase in real terms	0	3%	3%
Total increase	0	5.50%	5.50%
Actual cost	120.0	126.6	126.6
Total cost	480,000	633,000	696,300	1,809,300
Personnel	50,000	50,000	50,000	150,000
CCA	4%	4%	4%
Total Cost	52,000	52,000	52,000	156,000
Profit	468,000	633,750	782,109	1,883,859
Tax	35%	35%	35%
PAT - profit after tax	304,200	411,938	508,371	1,224,509
Additional Working capital	150,000	47,813	31,749
Year	Opening Amt	Interest	Balance
0	(1,800,000)	-225,000.00	-2,025,000.00
1	-1,870,800.00	-233,850.00	-2,104,650.00
2	-1,740,525.00	-217,565.60	-1,958,090.60
3	(181,468.4)	(22,683.6)	25,409.4

NPV -- 25049$

Opening Amount calcualtion

Yr 0 - R & D expense + Factory cost

Yr 1 - Yr0 balance + yr1 PAT - Yr 1 WC

Yr 2 - Yr 1 balance +yr2 PAT-Yr 2 WC

Yr 3 - Yr2 Balance + yr 3 PAT - yr3 WC + Sale value

Yr 3 closing - Yr 3 Opening + interest + 3 yrs WC total