Question

With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital, they decided to focus on surf print table and floor lamps to accent people’s homes. They projected unit sales of these lamps to be 10,800 in the first year, with growth of 7 percent each year for the next five years. Production of these lamps will require $61,000 in net working capital to start. Total fixed costs are $149,000 per year, variable production costs are $19 per unit, and the units are priced at $62 each. The equipment needed to begin production will cost $615,000. The equipment will be depreciated using the straight-line method over a 5-year life and is not expected to have a salvage value. The tax rate is 23 percent and the required rate of return is 19 percent. What is the NPV of this project?

Answer 1

Ans.

Net Present Value = Present Value of Cash Outflow - Present Value of Cash Inflows

Year 1 quantity = 10,800

Year 2 quantity = 10,800(1 + .07) = 11,556

Year 3 quantity = 11,556(1 + .07) = 12,364.92

Year 4 quantity = 12,364.92(1 + .07) = 13,230.4644

Year 5 quantity = 13,230.4644(1 + .07) = 14,156.596908

Now we can calculate the sales revenue and variable costs each year. The pro forma income statements and operating cash flow each year will be:

	0	1	2	3	4	5
Units Sold		10,800	11,556	12,364.92	13,230.4644	14,156.59691
Revenue ( units * $ 62)		$          669,600.00	$         716,472.00	$    766,625.04	$    820,288.79	$    877,709.01
Less : Fixed Cost		$          149,000.00	$         149,000.00	$    149,000.00	$    149,000.00	$    149,000.00
Less : Variable Cost (units * $ 19)		$          205,200.00	$         219,564.00	$    234,933.48	$    251,378.82	$    268,975.34
Less : Depreciation ($ 615,000 /5 )		$          123,000.00	$         123,000.00	$    123,000.00	$    123,000.00	$    123,000.00
Earning before tax		$          192,400.00	$         224,908.00	$    259,691.56	$    296,909.97	$    336,733.67
Less : Taxes @ 23%		$            44,252.00	$           51,728.84	$      59,729.06	$      68,289.29	$      77,448.74
Net Income		$          148,148.00	$         173,179.16	$    199,962.50	$    228,620.68	$    259,284.92
Add : Depreciation		$          123,000.00	$         123,000.00	$    123,000.00	$    123,000.00	$    123,000.00
Operating Cash Flow (a)	$                                                  -	$          271,148.00	$         296,179.16	$    322,962.50	$    351,620.68	$    382,284.92
Capital Spending (b)	$                              (615,000.00)	$                            -	$                           -	$                      -	$                      -	$                      -
Working Capital (c)	$                                (61,000.00)	$                            -	$                           -	$                      -	$                      -	$      61,000.00
Total Cash Flows [d = (a + b + c)]	$                              (676,000.00)	$          271,148.00	$         296,179.16	$    322,962.50	$    351,620.68	$    443,284.92
Discounting Factor @ 19% (e)	1	0.840336134	0.706164819	0.593415814	0.498668751	0.419049371
Present Value (f = d * e)	$                              (676,000.00)	$          227,855.46	$         209,151.30	$    191,651.06	$    175,342.24	$    185,758.27
Net Present Value (g)	$                                313,758.33

As the NPV is positive Project should be accepted.