Question

Dickinson Brothers, Inc., is considering investing in a machine to produce computer keyboards. The price of the machine will be $1,750,000, and its economic life is five years. The machine will be fully depreciated by the straight-line method. The machine will produce 28,000 keyboards each year. The price of each keyboard will be $62 in the first year and will increase by 5 percent per year. The production cost per keyboard will be $28 in the first year and will increase by 6 percent per year. The project will have an annual fixed cost of $290,000 and require an immediate investment of $255,000 in net working capital. The corporate tax rate for the company is 21 percent. The appropriate discount rate is 10 percent.

  

What is the NPV of the investment? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

SOLUTION:

The values provided in the question are as follows:

Dickinson Brothers, Inc. is considering investing in a machine to produce computer keyboards. Price of the machine i.e. initial investment = $1,750,000 Projects economic life = 5years. The machine will be fully depreciated by the straight-line method. The machine will produce 28,000 keyboards each year. The price of each keyboard will be $62 in the first year and will increase by 5 percent per year. The production cost per keyboard will be $28 in the first year and will increase by 6 percent per year. annual fixed cost =$290,000 require an immediate investment of in net working capital.= $255,000 Corporate tax rate for the company = 21 percent. or 0.21 Discount rate = 10 percent.

NPV of the investment =? àCalculation of depreciation per year Depreciation =(initial investment – salvage value )/ Projects economic life Using the values,

Depreciation= ($1,750,000 -0)/5

Depreciation=$350,000

Calculation of investment at the year end of 0 year

Investment = Initial Investment + Net working capital

Investment =$1,750,000+$255,000

Investment=$2,005,000

CALCULATION OF SALES
YEAR	PRICE OF KEYBOARD	PRODUCTION OF KEYBOARD	SALES	PRICE INCREASE 5%PER YEAR
A	B	C	D=B*C	E
YEAR 1	$62.00	28,000	1,736,000.00	62.00
YEAR2	$65.10	28,000	$1,822,800.00	62.00*1.05=65.10
YEAR3	$68.36	28,000	$1,913,940.00	65.10*1.05=68.36
YEAR4	$71.77	28,000	$2,009,637.00	68.36*1.05=71.77
YEAR5	$75.36	28,000	$2,110,118.85	71.77*1.05=75.36
CALCULATION OF VARIABLE COST
YEAR	PRODUCTION COST	PRODUCTION OF KEYBOARD	VARIABLE COST	VARIABLE COST 6% PER YEAR
A	B	C	D=B*C	E
YEAR 1	28.00	28,000	784000.00	28.00
YEAR2	29.68	28,000	831040.00	28*1.06=29.68
YEAR3	31.46	28,000	880902.40	29.68*1.06=31.46
YEAR4	33.35	28,000	933756.54	31.46*1.06=33.35
YEAR5	35.35	28,000	989781.94	33.35*1.06=35.35
CALCULATION OF AFTER TAX CASH INFLOW
PARTICULARS	YEAR 1	YEAR2	YEAR3	YEAR4	YEAR5
SALES	$1,736,000.00	$1,822,800.00	$1,913,940.00	$2,009,637.00	$2,110,118.85
LESS: VARIABLE COST	$784,000.00	$831,040.00	$880,902.40	$933,756.54	$989,781.94
LESS: FIXED COST	$290,000.00	$290,000.00	$290,000.00	$290,000.00	$290,000.00
LESS: DEPRECIATION	$350,000.00	$350,000.00	$350,000.00	$350,000.00	$350,000.00
NET SURPLUS	$312,000.00	$351,760.00	$393,037.60	$435,880.46	$480,336.91
(1- TAX )i.e (1-0.21)	0.79	0.79	0.79	0.79	0.79
AFTER TAX CASH INFLOW	$246,480.00	$277,890.40	$310,499.70	$344,345.56	$379,466.16
CALCULATION OF NET PRESENT VALUE (NPV )
YEAR	INVESTMENT	AFTER TAX CASH INFLOW	DEPRECIATION	TOTAL	PV FACTOR @10 %	PV OF CASHFLOW
A	B	C	D	E=B+C+D	F	G=E*F
0	-$2,005,000.00			-$2,005,000.00	1.0000	-$2,005,000.00
1		$246,480.00	$350,000.00	$596,480.00	0.9091	$542,259.97
2		$277,890.40	$350,000.00	$627,890.40	0.8264	$518,888.63
3		$310,499.70	$350,000.00	$660,499.70	0.7513	$496,233.42
4		$344,345.56	$350,000.00	$694,345.56	0.6830	$474,238.02
5		$379,466.16	$350,000.00	$729,466.16	0.6209	$452,925.54
NET PRESENT VALUE						$479,545.58