Question

FIN 503

Fall 2020

Chapter 3

Assignment 3

Please answer all questions. Do not leave any question unanswered. Show your calculations. Submit the homework through LMS only. Typed answers are preferred but not required. Assignment is due on 11/10/2020 at 11:55 PM

Project X involves a new type of graphite composite in-line skate wheel. We think we can sell 6,000 units per year at a price of $1,000 each.

Variable costs will run about $400 per unit, and the product should have a four-year life.    

Fixed costs for the project will run $450,000 per year. Further, we will need to invest a total of $1,250,000 in manufacturing equipment. This equipment is seven-year MACRS property for tax purposes. In four years, the equipment will be worth about half of what we paid for it. We will have to invest $1,150,000 in net working capital at the start. After that, net working capital requirements will be 25 percent of sales.

First prepare a pro forma income statement for each year.

Next calculate operating cash flow.

Finish the problem by determining total/project cash flow and then calculating NPV assuming a 28 percent required return.

Use a 34 percent tax rate throughout.

Answer 1

Part (a)

Pro forma income statement

Please see the table below. All financials are in $. Please see the second column to understand the mathematics.

Year, n	Linkage	0	1	2	3	4
Cost of equipment	A	1,250,000
7 years MACRS dep schedule	d		14.29%	24.49%	17.49%	12.49%
Pro forma Income Statement
Sales revenue	B = 6,000 x 1,000		6,000,000	6,000,000	6,000,000	6,000,000
[-] Variable cost	C = 6,000 x 400		2,400,000	2,400,000	2,400,000	2,400,000
[-] Fixed costs	D		450,000	450,000	450,000	450,000
[-] Depreciation	E = A x d		178,625	306,125	218,625	156,125
EBIT	F = B - C - D - E		2,971,375	2,843,875	2,931,375	2,993,875
[-] Taxes	G = 34% x F		1,010,268	966,918	996,668	1,017,918
NOPAT	H = F - G		1,961,108	1,876,958	1,934,708	1,975,958

Part (b)

Operating cash flows = NOPAT + Depreciation

Year, n	Linkage	0	1	2	3	4
NOPAT	H		1,961,108	1,876,958	1,934,708	1,975,958
[+] Depreciation	E		178,625	306,125	218,625	156,125
Operating cash flows	E + H		2,139,733	2,183,083	2,153,333	2,132,083

Part (c)

Year, n	Linkage	0	1	2	3	4
Operating cash flows	A		2,139,733	2,183,083	2,153,333	2,132,083
Capital investment	B	-1,250,000
Working capital reqd	C	1,150,000	1,500,000	1,500,000	1,500,000	1,500,000
Investment in working capital	D = Diff of C	-1,150,000	-350,000			1,500,000
Salvage value of machine	E = 0.5 x B					625,000
Book value of equipment	F = A - sum of all the depreciation from income statement					390,500
Gain on sale	G = E - F					234,500
Tax on gain	H = -34% x G					-79,730
Post tax salvage value	I = E + H					545,270
Net Cash flows	J = A + B + D + I	-2,400,000	1,789,733	2,183,083	2,153,333	4,177,353
Discount factor	K = (1 + 28%)^(-n)	1.0000	0.7813	0.6104	0.4768	0.3725
Discounted cash flows	L = J x K	-2,400,000	1,398,229	1,332,448	1,026,789	1,556,185
NPV	Sum of all L	2,913,650