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A company is intending to invest in a capital budgeting project to manufacture a medical testing...

A company is intending to invest in a capital budgeting project to manufacture a medical testing device and has projected the following sales:

Year 1 Year 2 Year 3                    Year 4 Year 5

50,000                   66,400                   81,200                   68,500                   54,500

The installed cost of the new assets will be $18,500,000 which will be depreciated using the 7-year MACRS schedule. The assets will have a salvage value of $3,700,000. Initial NWC requirements are $1,500,000 and additional working capital needs are estimated to be 15% of the projected sales increases for the following year. Total fixed costs are $2,000,000 per year. The medical device has a selling price of $300 per unit and variable production costs are $175. The firm has a marginal tax rate of 35% and a required rate of return of 18%. Analyze this project and give your recommendation as to whether they should invest in it or abandon it.

caculate all the results below:

FC 2,000,000
Profits
-DEP
EBT
-TAXES
EAT
+DEP
-/+ NWC 738,000

Solutions

Expert Solution

jeff jeffy answered 2 years ago
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Tax rate 35%
Calculation of annual depreciation
Depreciation Year-1 Year-2 Year-3 Year-4 Year-5 Total
Cost $           18,500,000 $     18,500,000 $      18,500,000 $      18,500,000 $     18,500,000
Dep Rate 14.29% 24.49% 17.49% 12.49% 8.93%
Depreciation Cost * Dep rate $             2,643,650 $       4,530,650 $        3,235,650 $        2,310,650 $       1,652,050 $      14,372,650
Calculation of after-tax salvage value
Cost of machine $     18,500,000
Depreciation $     14,372,650
WDV Cost less accumulated depreciation $       4,127,350
Sale price $       3,700,000
Profit/(Loss) Sale price less WDV $         (427,350)
Tax Profit/(Loss)*tax rate $         (149,573)
Sale price after-tax Sale price less tax $       3,849,573
Calculation of annual operating cash flow
Year-1 Year-2 Year-3 Year-4 Year-5
No of units                       50,000                 66,400                  81,200                  68,500                 54,500
Selling price $                        300 $                  300 $                   300 $                   300 $                  300
Operating cost $                        175 $                  175 $                   175 $                   175 $                  175
Sale $           15,000,000 $     19,920,000 $      24,360,000 $      20,550,000 $     16,350,000
Less: Operating Cost $             8,750,000 $     11,620,000 $      14,210,000 $      11,987,500 $       9,537,500
Contribution $             6,250,000 $       8,300,000 $     10,150,000 $       8,562,500 $       6,812,500
Less: Fixed cost $             2,000,000 $       2,000,000 $        2,000,000 $        2,000,000 $       2,000,000
Less: Depreciation $             2,643,650 $       4,530,650 $        3,235,650 $        2,310,650 $       1,652,050
Profit before tax (PBT) $             1,606,350 $       1,769,350 $       4,914,350 $       4,251,850 $       3,160,450
Tax@35% PBT*Tax rate $                562,223 $          619,273 $        1,720,023 $        1,488,148 $       1,106,158
Profit After Tax (PAT) PBT - Tax $             1,044,128 $       1,150,078 $       3,194,328 $       2,763,703 $       2,054,293
Add Depreciation PAT + Dep $             2,643,650 $       4,530,650 $        3,235,650 $        2,310,650 $       1,652,050
Cash Profit after-tax $             3,687,778 $       5,680,728 $       6,429,978 $       5,074,353 $       3,706,343
Calculation of working capital movement
Projected Increase in sale in next year $                             -   $             4,920,000 $       4,440,000 $      (3,810,000) $      (4,200,000)
Additional working capital required $               1,500,000 $                738,000 $          666,000 $          (571,500) $          (630,000)
Calculation of NPV
18.00%
Year Capital Working capital Operating cash Annual Cash flow PV factor, 1/(1+r)^time Present values
0 $         (18,500,000) $      (1,500,000) $    (20,000,000)                 1.0000 $    (20,000,000)
1 $         (738,000) $        3,687,778 $        2,949,778                 0.8475 $        2,499,811
2 $         (666,000) $        5,680,728 $        5,014,728                 0.7182 $        3,601,499
3 $          571,500 $        6,429,978 $        7,001,478                 0.6086 $        4,261,315
4 $          630,000 $        5,074,353 $        5,704,353                 0.5158 $        2,942,242
5 $             3,849,573