Question

Use the following information to answer the 8 questions (filling in the blanks) that follow it. When answering the questions, DO NOT use dollar signs, USE commas to separate thousands, DO NOT use parenthesis to denote negative numbers, USE the negative sign and place it in front of first digit of your answer when your answer is a negative number. Round to the nearest dollar (do not enter decimals). For example, if your answer is -$1,245,300.40 then enter -1,245,300

RET Inc. currently has one product, low-priced stoves. RET Inc. has decided to sell a new line of medium-priced stoves. Sales revenues for the new line of stoves are estimated at $50 million a year. Variable costs are 60% of sales. The project is expected to last 10 years. Also, non-variable costs are $10,000,000 per year. The company has spent $4,000,000 in research and a marketing study that determined the company will lose (cannibalization) $10 million in sales a year of its existing low-priced stoves. The production variable cost of the existing low-priced stoves is $8 million a year.

The plant and equipment required for producing the new line of stoves costs $30,000,000 and will be depreciated down to zero over 30 years using straight-line depreciation. It is expected that the plant and equipment can be sold (salvage value) for $12,000,000 at the end of 10 years. The new stoves will also require today an increase in net working capital of $5,000,000 that will be returned at the end of the project.

The tax rate is 20 percent and the cost of capital is 10%.

1. What is the initial outlay (IO) for this project?

2. What is the annual Earnings before Interests, and Taxes (EBIT) for this project?                                    

3. What is the annual net operating profits after taxes (NOPAT) for this project?

4. What is the annual incremental net cash flow (operating cash flow: OCF) for this project?

5. What is the remaining book value for the plant at equipment at the end of the project?

6. What is the cash flow due to tax on salvage value for this project? Enter a negative # if it is a tax gain. For example, if your answer is a tax on capital gains of $3,004.80 then enter   -3,005 ; if your answer is a tax shelter from a capital loss of $1,000,20 then enter 1,000

7. What is the project's cash flow for year 10 for this project?

8. What is the Net Present Value (NPV) for this project?

Answer 1

Solution -

NOTE -

Assumption 1 - It is assumed that depreciation form part of variable cost mentioned in the question. Otherwise answer may vary.

1	Initial Outlay of project
	Particulars		Amount
	Plant and Machinery		30,000,000
	Increase in WC		5,000,000
			35,000,000
2	Calculation of EBIT
	Particulars
	Sales Revenue		50,000,000
	Less - Variable cost		30,000,000
	Contribution		20,000,000
	Less - Non variable cost		10,000,000
	EBIT		10,000,000
3	NOPAT
	Particulars
	EBIT		10,000,000
	Less - Tax (20%)		2,000,000
	NOPAT		8,000,000
4	Incremental CF
	Particulars
	NOPAT		8,000,000
	Add - Depareciation		1,000,000
	Less - Cannibalization effect		2,000,000
	Incremental Net CF		7,000,000
5	Book value of P&M at end of project
	Particulars
	Purchase Price		30,000,000
	Less - Depreciation of 10 years	[(30,000,000/30)*10]	10,000,000
	Closing book value at end of project		20,000,000
6	Cashflow on salvage value
	Particulars
	Salvage value	(A)	12,000,000
	Less - Book value at Yr 10		20,000,000
	Loss as per tax provision		8,000,000
	Tax gain/loss (20%)	(B)	1,600,000
	Total cashflow	(A+B)	13,600,000
7	Project CF for year 10
	Particulars
	Operating CF		7,000,000
	CF on salvage value		13,600,000
	Working Capital		5,000,000
	Total CF for Yr 10		25,600,000
8	Calculation of NPV
	Pariculars	Amount	PV Factor	PV
	Inflow
	- Annual Operating CF for 9 years	7,000,000	5.75	40,320,000
	- CF on year 10	25,600,000	0.385	9,856,000
			(A)	50,176,000
	Outflow
	-Initial outflow	35,000,000	1	35,000,000
			(B)	35,000,000
	NPV		(A-B)	15,824,000