Question

Your company has been doing​ well, reaching $ 1.18million in​ earnings, and is considering launching a new product. Designing the new product has already cost $ 549, 000.The company estimates that it will sell 824, 000 units per year for $ 3.06per unit and variable​ non-labor costs will be $ 1.16per unit. Production will end after year 3. New equipment costing $ 1.13million 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 3and plan to scrap it. Your current level of working capital is $ 305, 000.The new product will require the working capital to increase to a level of $ 385, 000​ immediately, then to $ 407, 000 in year​ 1, in year 2 the level will be $ 344 comma 000​,and finally in year 3 the level will return to $ 305, 000.Your tax rate is 21 %.The discount rate for this project is 10.1 %.Do the capital budgeting analysis for this project and calculate its NPV.Note​:Assume that the equipment is put into use in year 1.

According to the bonus depreciation​ schedule, depreciation in year 1 will be ​    ​ (Round to the nearest​ dollar.)

Depreciation in years 2 and 3 will be $    ​(Round to the nearest​ dollar.)

Complete the capital budgeting analysis for this project​ below:

The NPV of the project is $

Answer 1

Since the equipment is put to use in Year-1, depreciation using the 100% bonus depreciation will be $1.13 million in Year-1.
In year 2 and 3 depreciation will be 0.

Calculation of Change in Working Capital :

	Year 0	Year 1	Year 2	Year 3
Opening Working Capital (a)	305,000	385,000	407,000	344,000
Closing Working Capital (b)	385,000	407,000	344,000	305,000
Increase/(Decrease) in Working Capital (a)-(b)	80,000	22,000	-63,000	-39,000

Calculation of NPV :

PARTICULARS	Year	0	1	2	3
INCREMENTAL REVENUES		0.00	2521440.00	2521440.00	2521440.00
INCREMENTAL OPERATING COSTS		0.00	955840.00	955840.00	955840.00
DEPRECIATION		0.00	1130000.00	0.00	0.00
EBIT		0.00	435600.00	1565600.00	1565600.00
INCOME TAX @21%		0.00	91476.00	328776.00	328776.00
UNLEVERED NET INCOME		0.00	344124.00	1236824.00	1236824.00
ADD : DEPRECIATION		0.00	1130000.00	0.00	0.00
LESS : CAPITAL EXPENDITURE		1130000.00	0.00	0.00	0.00
LESS : INCREASE IN NET WORKING CAPITAL		80000.00	22000.00	-63000.00	-39000.00
POUND FREE CASH FLOW		-1210000.00	1452124.00	1299824.00	1275824.00
PRESENT VALUE FACTOR @10.1%		1	0.90826521	0.8249457	0.74926948
PRESENT VALUE @10.1%		-1210000.00	1318913.71	1072284.22	955935.99
NPV = SUM OF PRESENT VALUE AT EACH YEAR				2137133.92

Since the NPV is positive, the project should be accepted.

Present Value Factor have been calculated as = (1/1+r)n
Where
r= Required rate of Return (Discount rate)
n= No of Periods

NOTE : The company has already incurred $549,000 which is a sunk cost. Hence the same has not been taken in our calculations.