Question

XYZ Inc. is considering a project to manufacture 2 million boxes of surgical face masks annually for five years, for selling price of $20 per box. To get the project started, XYZ must invest $15 million in new plant and equipment. Annual fixed costs are estimated to be $6 million and variable costs are estimated to be $12 per box. The CCA rate for the plant and equipment is 30%, and the firm's marginal tax rate is 35%. After five years, the plant and equipment can be sold for an estimated $2 million. XYZ estimates that net working capital will increase by $900,000 at the initiation of the project, and 90% of this amount will be recovered at the end of the project. What is the project's net present value if the required rate of return on projects of similar risk is 16%? Should XYZ run this project? Assume all cash flows, except CCA tax shields, occur at the end of the year.

Answer 1

Answer
Investment
Plant and Machinery	=	$                                      15,000,000.00
Working Capital	=	$                                            900,000.00
		$                                      15,900,000.00
No.of Boxes Manufatured	=	2000000
Seeling Price	=	$                                                      20.00
Variable Cost	=	$                                                      12.00
Contribution	=	$                                                        8.00
Contribution	=	$                                            16,000,000
Fixed Deposit	=	$                                              6,000,000
PBDT	=	$                                            10,000,000
Depreciation	=	$                                        4,500,000.00
PBT	=	$                                        5,500,000.00
Tax Rate @ 35%	=	$                                        1,925,000.00
PAT	=	$                                        3,575,000.00
Add : Dep	=	$                                            450,000.00
Cash flows	=	$                                        4,025,000.00
Rate of Return	=	16%
Terminal Cash Flows
Sale of Plant and Machinery	=	$                                              2,000,000
Tax @35%	=	$                                                 700,000
Net sale Proceeds	=	$                                              1,300,000
Working Capital	=	$                                            810,000.00	90% of Initial Working Capital
Total	=	$                                        2,110,000.00
Present value of cash flows	=	PVAF(16%,5 Years)+PVF(16%,5th Year)
PVAF(16%,5 Years)	=	1-(1+r)^-n/r
		(1-(1.16)^-5)/0.16
		3.2743
PVF(16%,5th Year)	=	1/(1+r)^-5
		(1/(1.16))^5
		0.4761
Present value of cash inflows	=	(6657500*3.2743)+(2110000*0.4761)
		$                                      22,803,223.25
NPV	=	Present value of cash inflows - Present Value of Cash Outflows
		22803223.25-15900000
NPV	=	$                                        6,903,223.25
As NPV is Positive XYZ inc. Should Run the Project