Question

XYZ Company is evaluating a project as to whether expansion would be advisable. Here are the parameters you must use to assess whether that is advisable. The Company's cost of capital is 9.6% and they are making a 1.75 percentage point adjustment to it for additional risk associated with the project. Five year life. 1. Cost of the Project: $750,000 Working Capital Required: $75,000 Depreciation: $120,000 per Year Salvage value recovery at the end of the project is $47,500. Company tax rate is 30%. Assume that there is no gain or loss at the end of the project. 2. Annual Cash Flow: Sales of product: 120 units at $3,650 each Fixed Costs: $42,500 Variable Costs: $1,920 per unit.

Answer 1

Answer : Let us first list down the parameters given to us in the question

Cost of capital : 9.6% + adjusted for additional risk (1.75% ) = 11.35% effective cost of capital

Life of the project 5 years

Cost of the project $750000

Working capital required : $75000

Depreciation : 120000

Salvage value : 47,500

Tax rate : 30%

Lets use Net present value method to calculate is the project workable or not.

If NPV is above 0 that means we can accept the project

Calculating present value formula : Fund flow/ ( 1 + interest rate) ^(No of years)

Calculation of Net present value

Years	0	1	2	3	4	5
Cost of project	750000
Working capital	75000
Sales		438000	438000	438000	438000	438000
Variable costs		230400	230400	230400	230400	230400
Fixed Costs		42500	42500	42500	42500	42500
EBITDA		165100	165100	165100	165100	165100
Depreciation		120000	120000	120000	120000	120000
EBIT		45100	45100	45100	45100	45100
Tax		13530	13530	13530	13530	13530
PAT		31570	31570	31570	31570	31570
Add back depreciation		151570	151570	151570	151570	151570
Salvage value		0	0	0	0	47500
Add back working capital		0	0	0	0	75000
Net Money benefit	-825000	151570	151570	151570	151570	274070
Cost of capital		11.35%	11.35%	11.35%	11.35%	11.35%
Present value	-825000	136120.3	122245.5	109784.9	98594.43	160107
Net Present value	-198148

As you can see NPV is negative which suggests project is not feasible for us.