Question

Your company has been doing​ well, reaching $1.03 million in​ earnings, and is considering launching a new product. Designing the new product has already cost $461,000. The company estimates that it will sell 844,000 units per year for$2.96 per unit and variable​ non-labor costs will be $1.09 per unit. Production will end after year 3. New equipment costing$1.04 million will be required. The equipment will be depreciated using​ 100% bonus depreciation under the 2017 TCJA. You think the equipment will be obsolete at the end of year 3 and plan to scrap it. Your current level of working capital is $295,000. The new product will require the working capital to increase to a level of $390,000 immediately, then to $390,000 in year​ 1, in year 2 the level will be $354,000​, and finally in year 3 the level will return to $295,000. Your tax rate is 21%. The discount rate for this project 9.8%. Do the capital budgeting analysis for this project and calculate its NPV.

Note​:

Assume that the equipment is put into use in year 1.

Answer 1

Calculation of NPV

Particulars	Year 1	Year 3	Year 4
Units	844,000	844,000	844,000
Price per unit	$                   2.96	$                   2.96	$                   2.96
Sale Revenue	$ 2,498,240.00	$ 2,498,240.00	$ 2,498,240.00
Less: Variable Cost	$      877,760.00	$      877,760.00	$      877,760.00
Contribution	$ 1,620,480.00	$ 1,620,480.00	$ 1,620,480.00
Less: Depreciation	$ 1,040,000.00	-	-
Profit before Tax	$      580,480.00	$ 1,620,480.00	$ 1,620,480.00
Less: Tax @ 21%	$      121,901.00	$      340,301.00	$      340,301.00
Profit after Tax	$      458,579.00	$ 1,280,179.00	$ 1,280,179.00
Add: Depreciation	$ 1,040,000.00	-	-
Less: Increase in Working Capital Requirement	$        95,000.00	-	-
Add: Decrease in Working Capital Requirement	-	$        36,000.00	$        59,000.00
Cash Flow	$ 1,403,579.00	$ 1,316,179.00	$ 1,339,179.00
Discounted Factor @ 9.8%	0.911	0.829	0.755
Discounted Cash Flows	1,278,660.47	1,091,112.39	1,011,080.15

Total Discounted Cash Flows = 33,80,853

Less: Initial Cost of Projects = 10,40,000

NPV = 23,40,853