Question

ABC Manufacturing expects to sell 1,025 units of product in 2021 at an average price of $100,000 each based on current demand.

The Chief Marketing Officer forecasts growth of 50 units per year through 2025. The $100,000 price will be constant for 5 years.

However, ABC cannot produce more than 1,000 units annually. They must update plant or replace it. If replaced, initial working capital of $5 million is required. RRR is 14%.

Using excel functions, calculate NPV for both update and replace options. Update Replace Initial investment in 2021 $ 115,000,000 $ 138,000,000 Terminal salvage value in 2025 $ 10,000,000 $ - Working capital investment required $ - $ 5,000,000 Useful life 5 years 5 years Total annual cash operating costs per unit $ 70,000 $ 60,000

Answer 1

Option 1: Update

Year	Initial Investment	Terminal Cash flow	Number of Unit	Contribution	Total Contribution	Cash flow	PV Factor @ 14%	Present Value
0	$ -115,000,000					$ -115,000,000	1.00000	$ - 115,000,000.00
1			1,025	$         30,000	$ 30,750,000	$ 30,750,000	0.87719	$ 26,973,684.21
2			1,075	$         30,000	$ 32,250,000	$ 32,250,000	0.76947	$ 24,815,327.79
3			1,125	$         30,000	$ 33,750,000	$ 33,750,000	0.67497	$ 22,780,288.67
4			1,175	$         30,000	$ 35,250,000	$ 35,250,000	0.59208	$ 20,870,829.78
5		$ 10,000,000	1,225	$         30,000	$ 36,750,000	$ 46,750,000	0.51937	$ 24,280,485.06
								$        4,720,615.51

Option 2: Replace

Year	Initial Investment	Working Capital	Number of Unit	Contribution	Total Contribution	Cash flow	PV Factor @ 14%	Present Value
0	$ -138,000,000	$             -5,000,000				$ -143,000,000	1.00000	$ -143,000,000.00
1			1,025	$         40,000	$ 41,000,000	$ 41,000,000	0.87719	$ 35,964,912.28
2			1,075	$         40,000	$ 43,000,000	$ 43,000,000	0.76947	$ 33,087,103.72
3			1,125	$         40,000	$ 45,000,000	$ 45,000,000	0.67497	$ 30,373,718.23
4			1,175	$         40,000	$ 47,000,000	$ 47,000,000	0.59208	$ 27,827,773.04
5		$              5,000,000	1,225	$         40,000	$ 49,000,000	$ 54,000,000	0.51937	$ 28,045,907.88
								$ 12,299,415.15