Blue Jeans Corp. has done an analysis of whether to continue offering a new line of...

Blue Jeans Corp. has done an analysis of whether to continue offering a new line of jeans or to halt operations, this analysis cost $250,000. The new product has expected sales at the end of this year of $800,000 and this grow every year by 3%. This product has created some cannibalization worth $75,000 of sales reduction each year. COGS is $200,000 at the end of this year and will also grow every year by 3%. COGS related to the cannibalized product is $25,000 each year. The line of jeans will be in production for three years, afterwards they become obsolete. The equipment cost of $2M ($2 million) was spent at the beginning of this year (t=0) and it has a 40% CCA rate. The space for the equipment could have received $10,000 each year in its next best alternative use. Interest charges are $50,000 annually. There will be a one-time net working capital increase of $20,000 at the end of year one; this will be recovered at the end of year 3. The firm demands a 5% return on projects such as this. The corporate tax rate is 30%. Assume that at the end of year 3 the equipment is sold for $0 and does not bring any tax consequences thereafter. What is the NPV of this project?

A $584,434 （I know this is the answer but I dont know the process please）

B -$550,910

с $354,306

D$547,368

E $531,847

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Expert Solution

Statement showing depreciation

Year	Opening balance	Depreciation Rates	Depreciation (Opening balance x Depreciation rates)	Closing Balance
1	2000000	20%	400000	1600000
2	1600000	40%	640000	960000
3	960000	40%	384000	576000

Statement showing NPV

Particulars	0	1	2	3	NPV = sum of PV
Equipment cost	-2000000
Expected sales		800000	824000	848720
Less
COGS		200000	206000	212180
Contribution loss form cannibalized product (75000-25000)		50000	50000	50000
Depreciation		400000	640000	384000
Loss of rental space		10000	10000	10000
PBT		140000	-82000	192540
Less : Tax @ 30%		42000	-24600	57762
PAT		98000	-57400	134778
Add: Depreciation		400000	640000	384000
Annual cash flow		498000	582600	518778
WC requirement		-20000		20000
Total cash flow	-2000000	478000	582600	538778
PVIF @ 5%	1.0000	0.9524	0.9070	0.8638
PV	-2000000	455238	528435	465417	-550910

Thus NPV = $-550910

Note)

1) $250000 spend is sunk cost hence not considered

2) Interest cost is not to be consider as it's effect is already included in cost of capital

jeff jeffy answered 1 year ago

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