Question

You have been hired as a consultant for Brilliant Paint Company, Inc. (BPC), manufacturers of fine industrial paint. The market for industrial paint is growing rapidly. The company bought some land three years ago for $1.35 million in anticipation of using it as a toxic paint waste dump site but has recently hired another company to handle all toxic materials. Based on a recent appraisal, the company believes it could sell the land for $1.45 million on an after-tax basis, however, if it waits for 6 years, the land could be sold for $1.55 million after taxes. The company also hired a marketing firm to analyze the paint market, at a cost of $120,000. An excerpt of the marketing report is as follows: The paint industry will have a rapid expansion in the next five years. With the brand name recognition that BPC brings to bear, we feel that the company will be able to sell 3,000 units in the first year of operation and will increase by 25% in the second. The unite growth will decrease to 20% in the third year and will continue to decrease linearly to 5% every year until the end of the project. Capitalizing on the name recognition of BPC, we feel that a premium price of $600 can be charged in the first year but due to competition the company needs to keep the price for at least three years. However, the company could increase the price to $625 in year three and maintain it until the end of project life. BPC believes that fixed costs for the project will be $500,000 per year, and variable costs are 20 percent of sales. The equipment necessary for production will cost $3 million and will be depreciated according to a six-year MACRS schedule. At the end of the project, the equipment can be scrapped for $375,000. Net working capital of $150,000 will be required immediately but needs to increase it by %5 per year as the sales increases. BPC has a 35 percent tax rate, and the required return on the project is 13 percent. What is the NPV of the project?

Answer 1

	0	1	2	3	4	5
Sales units		3000	3750	4500	5175	5692.5
Sales price		$600	$600	$625	$625	$625
Revenue		$18,00,000	$22,50,000	$28,12,500	$32,34,375	$35,57,813
variable cost		$3,60,000	$4,50,000	$5,62,500	$6,46,875	$7,11,563
Fixed cost		$5,00,000	$5,00,000	$5,00,000	$5,00,000	$5,00,000
Depreciation		$6,00,000	$9,60,000	$5,76,000	$3,45,600	$3,45,600
Income before tax		$2,10,000	$3,36,000	$2,01,600	$1,20,960	$1,20,960
Net income		$3,90,000	$6,24,000	$3,74,400	$2,24,640	$2,24,640
Operating cash flow		$9,90,000	$15,84,000	$9,50,400	$5,70,240	$5,70,240
Initial investment	-$46,00,000
Increase in working capital		-$7,500	-$7,500	-$7,500	-$7,500	$1,80,000
After tax Salvage value						$3,04,230
Net cash flow	-$46,00,000	$9,82,500	$15,76,500	$9,42,900	$5,62,740	$10,54,470
Cost of capital	$1	$0.885	$0.783	$0.693	$0.613	$0.543
PV of cash flows	-$46,00,000	$8,69,469	$12,34,631	$6,53,477	$3,45,139	$5,72,324
NPV	-$9,24,960

Working notes:

1) Initial investment

Equipment cost	$30,00,000
Land cost	$14,50,000
Working capital	$1,50,000
Initial investment	$46,00,000

2) After tax salvage value

Book value	$1,72,800
Sale value	$3,75,000
Profit on sale	$2,02,200
Tax on profits	$70,770
After tax salvage value	$3,04,230