Question

BAD company is considering producing a new range of smartphones that will require it to build a

new factory. Feasibility studies have been done on the factory which cost $5 million. The studies

have found the following:

1. The factory will cost $25 million and will have a useful life of 20 years.

2. The land where the factory will go is currently used as a carpark for workers and it is assumed that the company will have to pay $200000 per year for their workers to park in a nearby carpark.

3. The factory will be depreciated on a straight line basis and will have a salvage value of $0 but it is believed that most of it can be sold for scrap after 20 years for $50000.

4. Due to the nature of the business they are in, they will have to perform some environmental tests to make sure that some of the chemicals they are using are not entering the ground water around the factory. These tests will be performed every 5 years and cost $625000.

5. Through the building of this factory and the selling of the phones it produces, it’s revenue will increase by $5 million in year 1 and remain at this level for the operational life of the factory.

6. The extra costs that the company accrues per year due to the project are $435000 for labour, $50000 for overhead like power and water bills and marketing costs for the new line of phones will be $500000 per year but will decrease by $15000 per year as the phone gains greater penetration.

7. The company’s current cost of capital is 8% per year.

8. The tax rate is 30%.

9. The project requires an initial investment in working capital of $1000000 that is returned

   in year 20.

Use the above information to answer the following.

Calculate the NPV, IRR and payback period of the project. Should they go ahead with the project? ​

Answer 1

NPV = 4,803,753

IRR = 10.36% (IRR is the rate which would make NPV = 0 i.e cash outflows = cash inflows. This is dont by trial and error method by changing discount factor in below table column p. Or in excel with formula "=IRR(o1:o21)" IRR of years 0 to 20

Payback years = 15.41 (where NPV = 0, manually check which year the cash inflows = outflows). In year 15, we see NPV = -359023. So in year 16 NPV, use 359023/890558 (Year 16 NPV). so in year 16, in 0.4 years the NPV would be zero.

a	b	c	d	e	f	g	h	i	j	k	l	m	n	o	p	q
Years	Factory cost	Working capital	Depreciation	Salvage	Parking cost	Environment test	Revenue	Labour+overhead	Marketing	Net income	Tax @30%	Net profit	Net cash flow from operations	Total Net cash flow	Discount factor @ 8%	NPV
			Investment/20 yrs			(Once 5 years)			(Reduced by 15k every year)	=sum(d:j)	k*30%	=k-l	Add back depreciation (d)	=(b+c+n)	=(1/1+i^n	=o*p
0	-25,000,000	-1,000,000								0				-26,000,000	1.0000	-26,000,000
1			-1,250,000		-200,000		5,000,000	-385,000	-500,000	2,665,000	-799,500	1,865,500	3,115,500	3,115,500	0.9259	2,884,722
2			-1,250,000		-200,000		5,000,000	-385,000	-485,000	2,680,000	-804,000	1,876,000	3,126,000	3,126,000	0.8573	2,680,041
3			-1,250,000		-200,000		5,000,000	-385,000	-470,000	2,695,000	-808,500	1,886,500	3,136,500	3,136,500	0.7938	2,489,855
4			-1,250,000		-200,000		5,000,000	-385,000	-455,000	2,710,000	-813,000	1,897,000	3,147,000	3,147,000	0.7350	2,313,139
5			-1,250,000		-200,000	-625,000	5,000,000	-385,000	-440,000	2,100,000	-630,000	1,470,000	2,720,000	2,720,000	0.6806	1,851,186
6			-1,250,000		-200,000		5,000,000	-385,000	-425,000	2,740,000	-822,000	1,918,000	3,168,000	3,168,000	0.6302	1,996,377
7			-1,250,000		-200,000		5,000,000	-385,000	-410,000	2,755,000	-826,500	1,928,500	3,178,500	3,178,500	0.5835	1,854,624
8			-1,250,000		-200,000		5,000,000	-385,000	-395,000	2,770,000	-831,000	1,939,000	3,189,000	3,189,000	0.5403	1,722,917
9			-1,250,000		-200,000		5,000,000	-385,000	-380,000	2,785,000	-835,500	1,949,500	3,199,500	3,199,500	0.5002	1,600,547
10			-1,250,000		-200,000	-625,000	5,000,000	-385,000	-365,000	2,175,000	-652,500	1,522,500	2,772,500	2,772,500	0.4632	1,284,204
11			-1,250,000		-200,000		5,000,000	-385,000	-350,000	2,815,000	-844,500	1,970,500	3,220,500	3,220,500	0.4289	1,381,217
12			-1,250,000		-200,000		5,000,000	-385,000	-335,000	2,830,000	-849,000	1,981,000	3,231,000	3,231,000	0.3971	1,283,075
13			-1,250,000		-200,000		5,000,000	-385,000	-320,000	2,845,000	-853,500	1,991,500	3,241,500	3,241,500	0.3677	1,191,893
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