Question

The Bruin's Den Outdoor Gear is considering a new 6-year project to produce a new tent line. The equipment necessary would cost $1.29 million and be depreciated using straight-line depreciation to a book value of zero. At the end of the project, the equipment can be sold for 15 percent of its initial cost. The company believes that it can sell 23,500 tents per year at a price of $64 and variable costs of $25 per tent. The fixed costs will be $395,000 per year. The project will require an initial investment in net working capital of $193,000 that will be recovered at the end of the project. The required rate of return is 10.7 percent and the tax rate is 35 percent. What is the NPV?

Multiple Choice

• $918,509

• $545,989

• $403,416

• $635,749

• $457,864

Answer 1

Answer: NPV = 457,864

Solution:

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Sales	-	1,504,000	1,504,000	1,504,000	1,504,000	1,504,000	1,504,000
Less: Variable Costs	-	587,500	587,500	587,500	587,500	587,500	587,500
Less: Fixed Costs	-	395,000	395,000	395,000	395,000	395,000	395,000
Profit Before Depreciation	-	521,500	521,500	521,500	521,500	521,500	521,500
Less: Depreciation	-	215,000	215,000	215,000	215,000	215,000	215,000
Profit Before Tax	-	306,500	306,500	306,500	306,500	306,500	306,500
Less: Tax @ 35%	-	107,275	107,275	107,275	107,275	107,275	107,275
Profit after tax	-	199,225	199,225	199,225	199,225	199,225	199,225
Add back Depreciation	-	215,000	215,000	215,000	215,000	215,000	215,000
Cash flow from operations	-	414,225	414,225	414,225	414,225	414,225	414,225
Initial Investment	-1290000	-	-	-	-	-	-
Investment in NWC	-193000	-	-	-	-	-	193,000
After tax cash flow from sale of asset	-	-	-	-	-	-	125,775
Net Cash Flow	-1483000	414,225	414,225	414,225	414,225	414,225	733,000
Discount factor at 10.7%	1	0.903342	0.816027	0.737152	0.665901	0.601536	0.543393
Discounted Cash flow	-1483000	374187	338019	305347	275833	249171	398307
NPV =	457,864

NPV = Discounted cash inflows - cash outflows.

Excel Formulas:

Discount factor formula if solving without excel:

Where,
i = rate of return
n = number of periods