Question

RET Inc. currently has one product, low-priced stoves. RET Inc. has decided to sell a new line of medium-priced stoves. Sales revenues for the new line of stoves are estimated at $20 million a year. Variable costs are 80% of sales. The project is expected to last 10 years. Also, non-variable costs are $2,000,000 per year. The company has spent $3,000,000 in research and a marketing study that determined the company will lose (cannibalization) $4 million in sales a year of its existing low-priced stoves. The production variable cost of the existing low-priced stoves is $2 million a year.

The plant and equipment required for producing the new line of stoves costs $20,000,000 and will be depreciated down to zero over 20 years using straight-line depreciation. It is expected that the plant and equipment can be sold (salvage value) for $12,000,000 at the end of 10 years. The new stoves will also require today an increase in net working capital of $3,000,000 that will be returned at the end of the project.

The tax rate is 30 percent and the cost of capital is 10%.

1. What is the initial outlay (IO) for this project?

2. What is the annual Earnings before Interests, and Taxes (EBIT) for this project?                                    

3. What is the annual net operating profits after taxes (NOPAT) for this project?

4. What is the annual incremental net cash flow (operating cash flow: OCF) for this project?

5. What is the remaining book value for the plant at equipment at the end of the project?

6. What is the cash flow due to tax on salvage value for this project? Enter a negative # if it is a tax gain. For example, if your answer is a tax on capital gains of $3,004.80 then enter   -3,005 ; if your answer is a tax shelter from a capital loss of $1,000,20 then enter1,000

7. What is the project's cash flow for year 10 for this project?

8. What is the Net Present Value (NPV) for this project?

Answer 1

1-
Initial Outlay
cost of new equipment		-20000000
Investment in working capital		-3000000
total Initial outlay		-23000000
2-
Annual EBIT
annual sales		20000000
less variable cost-80%		16000000
less non operating cost		2000000
less loss of net loss due to canabalization of low price stove	(2000000-4000000)	2000000
less depreciation	20000000/20	1000000
Annual EBIT		-1000000
3-
Annual EBIT		-1000000
less taxes-30%		300000
NOPAT		-700000
4-
annual incremental net cash flow
NOPAT		-700000
Add depreciation		1000000
annual incremental net cash flow		300000
5-
remaining book value for the plant at equipment at the end of the project	purchasing cost of equipment-(annual depreciation*no. of years) = 20000000-(1000000*10)	10000000
6-
cash flow due to tax on salvage value for this project
gain on disposal of equipment	12000000-10000000	2000000
tax on gain on disposal of equipment	-2000000*30%	-600000
7-
project's cash flow for year 10 for this project
annual incremental net cash flow		300000
salvage value net of tax on gain	12000000-600000	11400000
recovery of working capital		3000000
cash flow for year 10		14700000
8-
Year	cash flow	present value factor @10% =1/(1+r)^n r =10%	present value of cash flow = cash flow*present value factor at10%
0	-23000000	1	-23000000
1	300000	0.9090909	272727.27
2	300000	0.8264463	247933.88
3	300000	0.7513148	225394.44
4	300000	0.6830135	204904.04
5	300000	0.6209213	186276.4
6	300000	0.5644739	169342.18
7	300000	0.5131581	153947.44
8	300000	0.4665074	139952.21
9	300000	0.4240976	127229.29
10	14700000	0.3855433	5667486.4
net present value =sum of present value of cash flow			-15604807