Question

Question 12 options: Use the following information to answer the 8 questions (filling in the blanks) that follow it. When answering the questions, DO NOT use dollar signs, USE commas to separate thousands, DO NOT use parenthesis to denote negative numbers, USE the negative sign and place it in front of first digit of your answer when your answer is a negative number. Round to the nearest dollar (do not enter decimals). For example, if your answer is -$1,245,300.40 then enter -1,245,300 REX Inc. currently has one product, low-priced stoves. REX Inc. has decided to sell a new line of medium-priced stoves. Sales revenues for the new line of stoves are estimated at $60 million a year. Variable costs are 90% of sales. The project is expected to last 10 years. Also, non-variable costs are 2,500,000 per year. The company has spent $1,000,000 in research and a marketing study that determined the company will lose (cannibalization) $2.8 million in sales a year of its existing low-priced stoves. The production variable cost of the existing low-priced stoves is $1.5 million a year. The plant and equipment required for producing the new line of stoves costs $15,000,000 and will be depreciated down to zero over 30 years using straight-line depreciation. It is expected that the plant and equipment can be sold (salvage value) for $10,00,000 at the end of 10 years. The new stoves will also require today an increase in net working capital of $3.500,000 that will be returned at the end of the project. The tax rate is 20 percent and the cost of capital is 10%. 1. What is the initial outlay (IO) for this project? 2. What is the annual Earnings before Interests, and Taxes (EBIT) for this project? 3. What is the annual net operating profits after taxes (NOPAT) for this project? 4. What is the annual incremental net cash flow (operating cash flow: OCF) for this project? 5. What is the remaining book value for the plant at equipment at the end of the project? 6. What is the cash flow due to tax on salvage value for this project? Enter a negative # if it is a tax gain. For example, if your answer is a tax on capital gains of $3,004.80 then enter -3,005 ; if your answer is a tax shelter from a capital loss of $1,000,20 then enter 1,000 7. What is the project's cash flow for year 10 for this project? 8. What is the Net Present Value (NPV) for this project?

Answer 1

Computation of NPV:

Sl No	Year	0	1-9	10
	Initial investment:
i	Cost of plant & equipment (Given)	-15,000,000
ii	Net increase in working capital (Given)	-3,500,000
iii	Total Initial investment (i+ii)	-18,500,000
	Operating cashflow:
iv	Sales revenue of new stove (Given)		60,000,000	60,000,000
v	Loss of sale of existing low price stove (Given)		-2,800,000	-2,800,000
vi	Incremental revenue (iv+v)		57,200,000	57,200,000
vii	Variable cost of new line of stove (Given)		-54,000,000	-54,000,000
viii	Variable cost saved due to loss of sale of existing low price stove (Given)		1,500,000	1,500,000
ix	Incremental variable cost (vii+viii)		-52,500,000	-52,500,000
x	Non-variable cost (Given)		-2,500,000	-2,500,000
xi	Depreciation (15,000,000/30years)		-500,000	-500,000
xii	EBIT (vi+ix+x+xi)		1,700,000	1,700,000
xiii	Tax @ 20% (xii*0.2)		-340,000	-340,000
xiv	NOPAT (xii+xiii)		1,360,000	1,360,000
xv	Add back: Depreciation (xi)		500,000	500,000
xvi	Net operating cashflow (xiv+xv)		1,860,000	1,860,000
	Terminal cashflow:
xvii	Sale of plant & equipment (Note 1)			10,000,000
xviii	Net working capital recovered (Given)			3,500,000
xix	Total terminal cashflow			13,500,000
xx	Net cashflow (iii+xvi+xix)	-18,500,000	1,860,000	15,360,000
xxi	PVF/PVAF @ 10%	1	5.7594	1/(1.1^10) = 0.3855
xxii	Present value of cashflow (xx*xxi)	-18,500,000	10,712,484	5,921,280

Note 1) Accumulated depreciation for 10years = 500,000*10years = 5,000,000
Remaining book value of plant at the end of project = Cost - Accumulated depreciation = 15million - 5million = 10million
Sale value of plant at the end of 10 years =10million
Capital gain/loss = Sale value - Book value = 10million-10million = 0
Tax on capital gain/loss also zero
But cash inflow at the end of 10year = 10million

Note 2) Reasearch & marketing study has already been incurred, it is not relevant for capital budgeting.

Answer to 1: Initial outlay = 18,500,000 (refer Sl no.iii in above table)
Answer to 2: EBIT = 1,700,000 (refer Sl no.xii in above table)
Answer to 3: NOPAT = 1,360,000 (refer Sl no.xiv in above table)
Answer to 4: OCF = 1,860,000 (refer Sl no.xvi in above table)
Answer to 5: Remaining book value = 10,000,000 (refer above note 1)
Answer to 6: Tax on salvage value = 0 (refer above note 1)
Answer to 7: Cashflow for year 10 = 15,360,000 (refer Sl no.xx in above table)
Answer to 8: NPV = ΣPresent value of cashflow = -1,866,236 (refer Sl no.xxii in above table)