Question
In: Finance
Your company wants to launch a new product. The price will be $108 and the projected...
Your company wants to launch a new product. The price will be $108 and the projected units sold will be 5,000 each of the next five years and then zero sales after that (i.e. life of five years). Variable costs per unit is $47 and fixed costs will be $36,000 per year. This project will need initial net working capital of $37,000, and NWC will then increase $7,000 per year through the end of year five. At that point 75% of NWC (no tax ramifications) will be returned to the company. Necessary equipment investment will be $900,000 and have a salvage value of 23%, net of tax. The depreciation will be straight-line over the life of this project. Your company’s current debt/equity ratio is 1.15 and this product is in line with the operations of the rest of your company. Your company is in the 21% tax bracket. Your equity investors demand a 13% return and your company’s bonds yield 5.3%. Even though no debt will be used, you still need to use your company’s WACC. Price is accurate within 5%, units sold within 3%, and variable & fixed costs within 2%. What is the NPV in the worst-case scenario?
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Expert Solution
We are supposed to calcualte the NPV of the worst case scenario.
Worst case scenario means:
- Price going down by 5%
- So the new price is (1-5%) x 108
- Units will go down by 3%
- So the new units is (1-3%) x 5000
- VC & FC will increase by 2%
- So the new VC is (1+2%) x 47
- So the new FC is (1+2%) x 36000
- Next we need to calculate the WACC:
- D/E ratio is 1.15 which means that debt is 1.15 and the equity is 1 so the total capital is 1.15+1 = 2.15
- WACC = weight of debt x cost of debt x (1-tax rate) + weight of
equity x cost of equity
- weight of debt = 1.15/2.15
- weight of equity = 1/2.15
- WACC = (1.15/2.15) x 5.3x (1-0.21) +(1/2.15) x 13
- WACC = 8.29% rounded to 2 decimal places
NPV is calculated as follows:
| Particulars | Remark | 0 | 1 | 2 | 3 | 4 | 5 |
| Units Sold | (1-3%) x 5000 | 4850.00 | $ 4,850.00 | $ 4,850.00 | $ 4,850.00 | $ 4,850.00 | |
| SP | (1-5%) x 108 | $ 102.60 | $ 102.60 | $ 102.60 | $ 102.60 | $ 102.60 | |
| Sales | SP x Units | $ 4,97,610.00 | $ 4,97,610.00 | $ 4,97,610.00 | $ 4,97,610.00 | $ 4,97,610.00 | |
| VC per unit | (1+2%) x 47 | $ 47.94 | $ 47.94 | $ 47.94 | $ 47.94 | $ 47.94 | |
| Total VC | Units x vc per unit | $ 2,32,509.00 | $ 2,32,509.00 | $ 2,32,509.00 | $ 2,32,509.00 | $ 2,32,509.00 | |
| Fixed cost | (1+2%) x 36000 | $ 36,720.00 | $ 36,720.00 | $ 36,720.00 | $ 36,720.00 | $ 36,720.00 | |
| EBITDA | Sales-Total VC-Fixed Cost | $ 2,28,381.00 | $ 2,28,381.00 | $ 2,28,381.00 | $ 2,28,381.00 | $ 2,28,381.00 | |
| Depreciation | 900000/5 = 180000 | $ 1,80,000.00 | $ 1,80,000.00 | $ 1,80,000.00 | $ 1,80,000.00 | $ 1,80,000.00 | |
| EBT | EBITDA-Depreciation | $ 48,381.00 | $ 48,381.00 | $ 48,381.00 | $ 48,381.00 | $ 48,381.00 | |
| Tax | 21% x EBT | $ 10,160.01 | $ 10,160.01 | $ 10,160.01 | $ 10,160.01 | $ 10,160.01 | |
| EAT | EBT-Tax | $ 38,220.99 | $ 38,220.99 | $ 38,220.99 | $ 38,220.99 | $ 38,220.99 | |
| Depreciation | Added back as non cash | $ 1,80,000.00 | $ 1,80,000.00 | $ 1,80,000.00 | $ 1,80,000.00 | $ 1,80,000.00 | |
| OCF | EAT+Depreciation | $ 2,18,220.99 | $ 2,18,220.99 | $ 2,18,220.99 | $ 2,18,220.99 | $ 2,18,220.99 | |
| FCINV | Given | $ -9,00,000.00 | |||||
| WCINV | Given | $ -37,000.00 | $ -7,000.00 | $ -7,000.00 | $ -7,000.00 | $ -7,000.00 | |
| WCINV Recovery | 75% x (37000+7000x5) | $ 48,750.00 | |||||
| Salvage value | 23% x (900000) | $ 2,07,000.00 | |||||
| FCF | OCF+FCINV+WCINV+WCINV recovery+Salvage value | $ -9,37,000.00 | $ 2,11,220.99 | $ 2,11,220.99 | $ 2,11,220.99 | $ 4,66,970.99 | $ 2,18,220.99 |
| Discount factor Formula | at WACC | 1/(1+0.0828606976744186)^0 | 1/(1+0.0828606976744186)^1 | 1/(1+0.0828606976744186)^2 | 1/(1+0.0828606976744186)^3 | 1/(1+0.0828606976744186)^4 | 1/(1+0.0828606976744186)^5 |
| Discount factor | Calculated using above formula | 1 | 0.923479818 | 0.852814974 | 0.787557417 | 0.72729338 | 0.671640758 |
| DCF | FCF x Discount Factor | $ -9,37,000.00 | $ 1,95,058.32 | $ 1,80,132.42 | $ 1,66,348.66 | $ 3,39,624.91 | $ 1,46,566.11 |
| NPV = sum of all DCF | $ 90,730.42 |
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