Question
In: Accounting
You work for Power In Motion Limited (PIM), a company specialized in motion sensor and related...
You work for Power In Motion Limited (PIM), a company specialized in motion sensor and related products. You are now reviewing information about a new product called U-Power, a kinetic energy generator that a person can wrap around his body to generate power and charge electronic gadgets. You think you should be able to sell $400 million worth of these devices per year for 3 years, starting at the end of this year. Your team has spent $5 million designing and test marketing the products in the past 2 years. Production of the devices will cost $200 million per year (includes both materials and salaries). If you were to launch the production, you will have to buy new equipment worth $80 million. This equipment will have a 4-year life and will be depreciated straight line to zero over that life. You plan to sell the equipment for $25 million at the end of the third year. Your company already had existing net working capital level at $20 million. Production of the new product will require you to increase your working capital from $20 million to $25 million immediately. Working capital will decrease back down to $20 million at the end of the third year. Your tax rate is 40%. What is the NPV of the project if the discount rate is 10%?
Solutions
Expert Solution
| Year | Cash flow in million(a) | Discounting factor (b) | Present value in million (a x b) |
| 0 | -$85.00 | 1 | -$85.00 |
| 1 | $128.00 | 0.909090909 | $116.36 |
| 2 | $128.00 | 0.826446281 | $105.79 |
| 3 | $156.00 | 0.751314801 | $117.21 |
| Total | $254.35 |
NPV of the project is $254.35 million.
| Notes: 1) | Discounting factor= | 1/ (1+r)^n | ||||||||
| r= rate of discounting | ||||||||||
| n= period | ||||||||||
| Discounting factor for year 1= | 1/(1+0.10)^1 | |||||||||
| Discounting factor for year 1= | 0.909090909 | |||||||||
| 2) | Cash outflow is showing as - ve sign | |||||||||
| 3) | Cash out flow at year 0 = | Cost of asset + increase in working capital level | ||||||||
| Cash out flow at year 0 = | $80 + $5 = $85 milion | |||||||||
| 4) | Depreciation: | Cost of asset - Salvage Value / Useful life | ||||||||
| Depreciation: | ($80-$0) / 4 | |||||||||
| Depreciation: | $20 Million | |||||||||
| 5) | Revenue | $400 | ||||||||
| Production cost | $200 | |||||||||
| Net cash flow before tax= | $400- $200 = $200 Million | |||||||||
| Cash flow after tax= | Net cash flow X (1- tax rate) | |||||||||
| Cash flow after tax= | $200 Million X (1- 0.40) | |||||||||
| Cash flow after tax= | $120 million | |||||||||
| Add tax benefit of depreciation= | Depreciation X tax | |||||||||
| i.e. $20 million X 0.40 = $8 million | ||||||||||
| Total cash in flow after tax = $120 + $8 = $128 million | ||||||||||
| 6) | Cost incurred in pase 2 years are sunk cost therefore it will not be considered. | |||||||||
| 7) | Increase in working capital level at year 0 i.e. Immidiately= | New level - existing level | ||||||||
| Increase in working capital level at year 0 i.e. Immidiately= | $25 Million - $20 milllion | |||||||||
| Increase in working capital level at year 0 i.e. Immidiately= | $5 milllion | |||||||||
| 8) | Cash flow from selling of asset at end of year 3= | $25 million | ||||||||
| Book value of asset at year 3= Cost of purchase - depreciation for year 1,2,3 | ||||||||||
| Book value of asset at year 3= | ($80 - $20-$20-$20) | |||||||||
| Book value of asset at year 3= | $20 | |||||||||
| Profit on sale of asset = | Sale proceed - Book value at year 3 | |||||||||
| Profit on sale of asset = | $25 - $20 million | |||||||||
| Profit on sale of asset = | $5 Million | |||||||||
| Tax on profit= | $ 5 million X 40% = $2 million | |||||||||
| After tax cash flow from sale of asset = $25-$2 = $23 million | ||||||||||
| 9) | Cash inflow at year 3= | Cash inflow from business+ Cash flow from sale of asset+ release of additional working capital | ||||||||
| Cash inflow at year 3= | $128+ $23+ $5 | |||||||||
| Cash inflow at year 3= | $156 million |
ekkarill92 answered 1 year ago