Question

Shultz Business Systems is analyzing an average-risk project, and the following data have been developed. Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no salvage value. This is just one of many projects for the firm, so any losses can be used to offset gains on other firm projects.

What is the project's expected NPV? Project cost of capital (r) 10.0% Net investment cost (depreciable basis) $200,000 Units sold 50,000 Average price per unit, Year 1 $25.00 Fixed op. cost excl. deprec. (constant) $150,000 Variable op. cost/unit, Year 1 $20.20 Annual depreciation rate 33.333% Expected inflation rate per year 5.00% Tax rate 25.0%

Answer 1

	0	1	2	3
Sales revenue [$25.00/Unit]		$      1,250,000	$     1,312,500	$   1,378,125
[5% inflation considered for years 2 &3]
Variable costs [$20.20/Unit]		$      1,010,000	$     1,060,500	$   1,113,525
[5% inflation considered for years 2 &3]
Fixed operating costs		$          150,000	$        150,000	$       150,000
[No inflation as it is given as constant]
Depreciation [200000*33.333%]		$            66,667	$           66,667	$         66,666
NOI		$            23,333	$           35,333	$         47,934
Tax at 25%		$              5,833	$             8,833	$         11,984
NOPAT		$            17,500	$           26,500	$         35,951
Add: Depreciation		$            66,667	$           66,667	$         66,666
OCF		$            84,167	$           93,167	$       102,617
Capital expenditure	$          200,000
FCF	$       (200,000)	$            84,167	$           93,167	$       102,617
PVIF at 10%	1	0.90909	0.82645	0.75131
PV at 10%	$       (200,000)	$            76,515	$           76,997	$         77,097
NPV	$            30,610