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

Tax rate		34%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Total
Cost		$       400,000	$      400,000	$       400,000	$       400,000	$      400,000
Dep Rate		20.00%	20.00%	20.00%	20.00%	20.00%
Depreciation	Cost * Dep rate	$         80,000	$        80,000	$         80,000	$         80,000	$        80,000	$       400,000
Calculation of after-tax salvage value
Cost of machine			$      400,000
Depreciation			$      400,000
WDV	Cost less accumulated depreciation	$                -
Sale price			$                -
Profit/(Loss)	Sale price less WDV	$                -
Tax	Profit/(Loss)*tax rate	$                -
Sale price after-tax	Sale price less tax		$                -
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5
No of units		10,000	10,000	10,000	10,000	10,000
Selling price		$           40.00	$          42.00	$           44.10	$           46.31	$          48.62	Increasing by 5% each year
Operating ost		$           20.00	$          22.00	$           24.20	$           26.62	$          29.28	Increasing by 10% each year
Sale		$       400,000	$      420,000	$       441,000	$       463,050	$      486,203
Less: Operating Cost		$       200,000	$      220,000	$       242,000	$       266,200	$      292,820
Contribution		$       200,000	$      200,000	$       199,000	$       196,850	$      193,383
Less: Depreciation		$         80,000	$        80,000	$         80,000	$         80,000	$        80,000
Profit before tax (PBT)		$       120,000	$      120,000	$       119,000	$       116,850	$      113,383
Tax@34%	PBT*Tax rate	$         40,800	$        40,800	$         40,460	$         39,729	$        38,550
Profit After Tax (PAT)	PBT - Tax	$         79,200	$        79,200	$         78,540	$         77,121	$        74,832
Add Depreciation	PAT + Dep	$         80,000	$        80,000	$         80,000	$         80,000	$        80,000
Cash Profit after-tax		$       159,200	$      159,200	$       158,540	$       157,121	$      154,832
Calculation of NPV
						15.00%
Year		Capital		Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0		$     (400,000)			$     (400,000)	1.0000	$     (400,000)
1				$       159,200	$       159,200	0.8696	$       138,435
2				$       159,200	$       159,200	0.7561	$       120,378
3				$       158,540	$       158,540	0.6575	$       104,243
4				$       157,121	$       157,121	0.5718	$         89,834
5		$                 -		$       154,832	$       154,832	0.4972	$         76,979
					Net Present Value	$       129,869