Question
In: Finance
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
| 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 |
jeff jeffy answered 1 year ago