Question

Dime a Dozen Diamonds makes synthetic diamonds by treating carbon. Each diamond can be sold for $120. The materials cost for a standard diamond is $60. The fixed costs incurred each year for factory upkeep and administrative expenses are $204,000. The machinery costs $1.5 million and is depreciated straight-line over 10 years to a salvage value of zero.

Looking to get a better understadning of this question, so that it can be solved. thank you!

Answer 1

Here you have provided with the data by using it you have to prepare the income statement and then derive the cash flow. Using discounted cash flow method then you have to calculate the net present value of this project and make decision whether to accept or reject this project.

Selling price per diamond and cost per diamond is given to you so you can multiply it with quantity and arrive at sales value and cost. Fixed cost is given. Depreciation can be calculated by dividing initial cost of machinery by its useful life years. you will have operating income by subtracting all expenses from sales then calculate the tax expense on operating income and subtract it from operating income you will get net operating profit after tax. (NOPAT)

Add depreciation to NOPAT which will give you cash flow. Discount the cash flow by using cost of capital which will give you present value of cash flows subtract the initial machinery cost from present value which will give you Net present value. If net present value is positive accept the project else reject.

Thanks.