Question

Your company has been doing​ well, reaching $1.16 million in​ earnings, and is considering launching a new product. Designing the new product has already cost $515,000. The company estimates that it will sell 753,000 units per year for $3.03 per unit and variable​ non-labor costs will be $1.07 per unit. Production will end after year 3. New equipment costing $1.12 million will be required. The equipment will be depreciated using​ 100% bonus depreciation under the 2017 TCJA. You think the equipment will be obsolete at the end of year 3 and plan to scrap it. Your current level of working capital is $291,000. The new product will require the working capital to increase to a level of $370,000 immediately, then to $400,000 in year​ 1, in year 2 the level will be $340,000​, and finally in year 3 the level will return to $291,000. Your tax rate is 21%. The discount rate for this project is 10.2%. Do the capital budgeting analysis for this project and calculate its NPV.

Note​: Assume that the equipment is put into use in year 1.

Answer 1

Ref	Particulars		Year 1	Year 2	Year 3
a	Operating cash flow		$ 1,475,880.00	$         1,475,880.00	$ 1,475,880.00
b	Depreciation		$ (1,120,000.00)	$                             -	$                     -
c=a-b	Profit before tax		$ 2,595,880.00	$         1,475,880.00	$ 1,475,880.00
	Less: taxes		$     545,134.80	$            309,934.80	$    309,934.80
	Profit after tax		$ 2,050,745.20	$         1,165,945.20	$ 1,165,945.20
	Add: depreciation		$ (1,120,000.00)	$                             -	$                     -
	Add/ (less): working capital		$      (30,000.00)	$               60,000.00	$      49,000.00
	Cash flow after tax		$     900,745.20	$         1,225,945.20	$ 1,214,945.20
d	Present value factor@ 10.2%		0.907441016	0.823449198	0.747231577
e=c*d	Present value of annual cashflows		$     817,373.14	$         1,009,503.59	$    907,845.42
	Total present value of annual cash inflows		$ 2,734,722.15
	Less: working capital		$    (109,000.00)
	Less: investment		$ (1,120,000.00)
	NPV		$ 1,505,722.15

NPV is $1,505,722.15

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