Question

RBC, is considering a five-year investment in a machine to produce widgets. Before investing, the Students at RBC, completed a marketing study on the demand of the widget. The marketing study cost $350,000. The machine cost is $1,000,000 and produces 30,000 widgets annually. At the end of the year, the variable cost is $45 per widget and it is expected to grow at 3%, the sales price is $60 per widget and expected to grow at 5%, and the fixed costs to operate the machine are $150,000 annually. The cost of the plant is depreciated in straight line over 5 years. The appropriate annual discount rate is 15% and the corporate tax rate is 21%. The machine will be place in a building at RBC that is currently being rented at the beginning of each year for $50,000. The required net working capital is $45,000 per year for the first three years, and $65,000 for the last two years, and it is recovered at the end of the project. At the end of the project RBC is expected to sell the machine for $100,000. RBC expects to sell all widgets produced each year. Find out Should RBC invest in this project?

Answer 1

Tax rate		21%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Total
Cost		$         1,000,000	$         1,000,000	$         1,000,000	$         1,000,000	$         1,000,000
Dep Rate		20.00%	20.00%	20.00%	20.00%	20.00%
Depreciation	Cost * Dep rate	$            200,000	$            200,000	$            200,000	$            200,000	$            200,000	$        1,000,000
Calculation of after-tax salvage value
Cost of machine			$         1,000,000
Depreciation			$         1,000,000
WDV	Cost less accumulated depreciation	$                       -
Sale price			$            100,000
Profit/(Loss)	Sale price less WDV		$            100,000
Tax	Profit/(Loss)*tax rate	$              21,000
Sale price after-tax	Sale price less tax		$              79,000
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5
No of units		30,000	30,000	30,000	30,000	30,000
Selling price		$                60.00	$                63.00	$                66.15	$                69.46	$                72.93
Operating cost		$                45.00	$                46.35	$                47.74	$                49.17	$                50.65
Sale		$         1,800,000	$         1,890,000	$         1,984,500	$         2,083,725	$         2,187,911
Less: Operating Cost		$         1,350,000	$         1,390,500	$         1,432,215	$         1,475,181	$         1,519,437
Contribution		$            450,000	$            499,500	$            552,285	$            608,544	$            668,474
Less: Fixed cost		$            150,000	$            150,000	$            150,000	$            150,000	$            150,000
Less: Depreciation		$            200,000	$            200,000	$            200,000	$            200,000	$            200,000
Profit before tax (PBT)		$            100,000	$            149,500	$            202,285	$            258,544	$            318,474
Tax@21%	PBT*Tax rate	$              21,000	$              31,395	$              42,480	$              54,294	$              66,880
Profit After Tax (PAT)	PBT - Tax	$              79,000	$            118,105	$            159,805	$            204,249	$            251,595
Add Depreciation	PAT + Dep	$            200,000	$            200,000	$            200,000	$            200,000	$            200,000
Cash Profit after-tax		$            279,000	$            318,105	$            359,805	$            404,249	$            451,595
Payment of rent in beginning	$              50,000.00
Tax benefit at the end of year	$              10,500.00	50000*21%
Calculation of NPV
								15.00%
Year		Capital	Working capital	Rent payment	Tax benefit on rent	Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
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