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Plato Pharmaceuticals Ltd. has invested $100,000 to date in developing a new type of insect repellent....
Plato Pharmaceuticals Ltd. has invested $100,000 to date in developing a new type of insect repellent. The repellent is now ready for production and sale, and the marketing manager estimates that the product will sell 150,000 bottles a year for the first two years, 170,000 for year three and 200,000 for the next two years. The selling price of the insect repellent will be $6.00 a bottle and the variable costs are estimated to be $3.00 a bottle for Year one. For the next two years the selling price will be $6.50 with variable cost of $3.15 a bottle, and then selling price will be $7.00 after that with a variable cost of $3.55, and $3.80 per bottle. Fixed costs are expected to be $210,000 a year. The figure is made up of $160,000 additional fixed costs and $50,000 fixed costs relating to the existing business that will be apportioned to the new business. In order to produce the repellent, machinery and equipment costing $520,000 will have to be purchased immediately. The estimated residual (salvage) value of this machinery and equipment in five years’ time is $100,000. The business calculates depreciation following CCA rules. The business has a cost of capital of 12%. CCA 30% (50% rule applicable) of depreciation will be used, and taxes are paid at a rate of 40%. Required:
1. Create a cash flow statement for the project for the next 5 years
2. Calculate the net present value.
3. Calculate the internal rate of return.
4. Undertake sensitivity analysis to show how much the following factors would have to change before the project ceased to be feasible. a. The initial cost of machinery and equipment b. Fixed costs c. Variable costs/per bottle d. Selling Price per bottle of repellent e. The residual value of the machinery and equipment
5. Write a statement to explain which of these factors is the most sensitive one.
Solutions
Expert Solution
a. As a first step, depreciation is computed as given below as per cca
| Machinery | Amount | Depreciation at 30% | Net |
| Cost | 520,000 | ||
| year 1 50% | 260,000 | 78,000 | 442,000 |
| Year 2 | 442,000 | 132,600 | 309,400 |
| Year 3 | 309,400 | 92,820 | 216,580 |
| Year 4 | 216,580 | 64,974 | 151,606 |
| Year 5 | 151,606 | 45,482 | 106,124 |
| Salvage | 100,000 | ||
| Loss on sale | 6,124 |
b. The cash flows are calculated as given below
The apportioned fixed cost is ignored as its not relevant for this project.
| Particulars | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| Units | 150,000 | 150,000 | 170,000 | 200,000 | 200,000 |
| Selling price | 6.00 | 6.50 | 6.50 | 7.00 | 7.00 |
| Variable Cost | 3.00 | 3.15 | 3.15 | 3.55 | 3.80 |
| Contribution- Selling price minus Variable Cost | 3.00 | 3.35 | 3.35 | 3.45 | 3.20 |
| Contribution Value | 450,000 | 502,500 | 569,500 | 690,000 | 640,000 |
| Addl Fixed Cost | (160,000) | (160,000) | (160,000) | (160,000) | (160,000) |
| Depreciation | (78,000) | (132,600) | (92,820) | (64,974) | (45,482) |
| Loss on Sale | - | (6,124) | |||
| Net profit | 212,000 | 209,900 | 316,680 | 465,026 | 428,394 |
| Tax at 40% | 84,800 | 83,960 | 126,672 | 186,010 | 171,358 |
|
Operating Cash flow= contribution minus fixed cost |
290,000 | 342,500 | 409,500 | 530,000 | 480,000 |
| less Taxes | (84,800) | (83,960) | (126,672) | (186,010) | (171,358) |
| Cash flow net of taxes | 205,200 | 258,540 | 282,828 | 343,990 | 308,642 |
c. NPV Calculation
| Particulars | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| Investment | (100,000) | |||||
| Fixed Asset | (520,000) | |||||
| Cash flows net of taxes | 205,200 | 258,540 | 282,828 | 343,990 | 308,642 | |
| Salvage value | 100,000 | |||||
| Net | (620,000) | 205,200 | 258,540 | 282,828 | 343,990 | 408,642 |
| Discounting Factor at 12% | 1.00 | 0.89 | 0.80 | 0.71 | 0.64 | 0.57 |
| Discounted Cash flows- DCF | (620,000) | 183,214 | 206,107 | 201,311 | 218,612 | 231,875 |
| NPV | 421,118 | <total of dcf> |
d. IRR is calculated using trial and error method. basis that the IRR when NPV is 0 is 33.68% as given below
| Particulars | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| Investment | (100,000) | |||||
| Fixed Asset | (520,000) | |||||
| Cash flows net of taxes | 205,200 | 258,540 | 282,828 | 343,990 | 308,642 | |
| Salvage value | 100,000 | |||||
| Net | (620,000) | 205,200 | 258,540 | 282,828 | 343,990 | 408,642 |
| Discounting Factor at 33.68 | 1.00 | 0.75 | 0.56 | 0.42 |
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developing a new type of insect repellent. The repellent is now
ready for production and sale, and the marketing manager estimates
that the product will sell 150,000 bottles a year for the first two
years, 170,000 for year three and 200,000 for the next two years.
The selling price of the insect repellent will be $6.00 a bottle
and the variable costs are estimated to be $3.00 a bottle for Year...
Plato Pharmaceuticals Ltd. has invested $150,000 to date in developing a new type of insect repellent....Plato Pharmaceuticals Ltd. has invested $150,000 to date in
developing a new type of insect repellent. The repellent is now
ready for production and sale, and the marketing manager estimates
are found in the chart below.
Year
Bottles per year
Selling Price
Variable Cost
1
150,000
$6.00
$3.00
2
165,000
$6.00
$3.15
3
175,000
$6.95
$3.25
4
190,000
$6.95
$3.55
5
190,000
$7.95
$3.60
6
170,000
$7.95
$3.90
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