Question

C.M. Burns Enterprises, Inc. is considering investing in a machine to produce computer keyboards. The price of the machine will be $400,000 and its economic life five years. The machine will be fully depreciated by the straight line method. The machine will produce 10,000 units of keyboards each year. The price of each keyboard will be $40 in the first year, and it will increase at 5% per year. The production cost per unit of the keyboard will be $20 in the first year, and it will increase at 10% per year. The corporate tax rate for the company is 34%. If the appropriate discount rate is 15%, what is the NPV of the investment?

Answer 1

Please note the solution.

> Concept

Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project.

> Formula

NPV = Present Value of cash inflow (PVCI) - Present Value of cash outflow (PVCO)

> Calculation

1) PVCO = Machine cost

              = $ 400000

2) PVCI

Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
Sales	10000 * 40 = 400000	10000 * ( 40 * 1.05 ) = 420000	10000 * ( 40 * 1.052 ) = 441000	10000 * ( 40 * 1.053 ) = 463050	10000 * ( 40 * 1.054 ) = 486203
Less: Production cost	10000 * ( 20 ) = 200000	10000 * ( 20 * 1.1 ) = 220000	10000 * ( 20 * 1.12 ) = 242000	10000 * ( 20 * 1.13 ) = 266200	10000 * ( 20 * 1.14 ) = 292820
Less: Depreciation	- 80000	-80000	-80000	-80000	-80000
PBT	120000	120000	119000	116850	113383
- Tax	-40800	-40800	40460	39729	38550.22
PAT	79200	79200	78540	77121	74833
Add: Depreciation	80000	80000	80000	80000	80000
CFAT	159200	159200	158540	157121	154833
PV	138434.78	120378.07	104242.62	89834.44	76979.37

PVCI = $ 529869.29

3) NPV = 529869.29 - 400000

            = $ 129869.29 Answer