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With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden...

With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital, they decided to focus on surf print table and floor lamps to accent people’s homes. They projected unit sales of these lamps to be 12,000 in the first year, with growth of 8 percent each year for the next five years. Production of these lamps will require $85,000 in net working capital to start. Total fixed costs are $185,000 per year, variable production costs are $21 per unit, and the units are priced at $67 each. The equipment needed to begin production will cost $675,000. The equipment will be depreciated using the straight-line method over a 5-year life and is not expected to have a salvage value. The tax rate is 25 percent and the required rate of return is 19 percent. What is the NPV of this project?

Solutions

Expert Solution

  • Initial Investment = Equipment Cost + Working Capital = 675,000 + 85,000 = $ 760,000
  • Calculation of Cash Flow each year :-
Particulars Year 1 Year 2 Year 3 Year 4 Year 5
Unit Sales (increasing @ 8% p.a.) 12000 12960 13997 15117 16326
Contribution per unit [67-21] 46 46 46 46 46
Total Contribution 552,000 596,160 643,862 695,382 750,996
(-) Fixed Costs 185,000 185,000 185,000 185,000 185,000
(-) Depreciation [675000/5] 135,000 135,000 135,000 135,000 135,000
= Net Income 232,000 276,160 323,862 375,382 430,996
(-) Tax @ 25% 58,000 69,040 80,966 93,846 107,749
Profit after Tax 174,000 207,120 242,896 281,536 323,247
(+) Depreciation 135,000 135,000 135,000 135,000 135,000
= Cash Flow after Tax 309,000 342,120 377,896 416,536 458,247
  • Calculation of NPV:-
Year Cash Flow DF @ 19% Present value of cash inflows
1 309000 0.8403 259653
2 342120 0.7062 241605
3 377896 0.5934 224243
4 416536 0.4987 207727
5 543247 [458247+85000] 0.4190 227620

Total present value of all cash inflows = $ 11,60,848

Initial Investment = $ 760,000

Hence Net Present Value = Total present value of all cash inflows - Initial Investment = 1160848 - 760000 = 400,848

Net Present Value [NPV] of this project is $ 400,848

ekkarill92 answered 1 year ago
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