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XYZ Inc. is considering a project to manufacture 2 million boxes of surgical face masks annually...
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.
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Expert Solution
| AMOUNTS IN $ | |||||||
| PARTICULARS | UNITS | YEARS | |||||
| PRODUCT | 1 | 2 | 3 | 4 | 5 | TOTAL | |
| SURGICAL FACE MASK | 2,000,000 | ||||||
| SALES PRICE/UNIT IN $ | 20 | ||||||
| VARIABLE COST/UNIT -IN $ | 12 | ||||||
| CASH OUTFOW IN PLANT & EQUIPMENT | 15,000,000 | ||||||
| WORKING CAPITAL INCREASE | 900,000 | ||||||
| CASH INFLOW | |||||||
| SALES VALUE -2 MILLION@ 20 | 40,000,000 | 40,000,000 | 40,000,000 | 40,000,000 | 40,000,000 | ||
| VARIABLE COST -2 MILLION@ 12 | 24,000,000 | 24,000,000 | 24,000,000 | 24,000,000 | 24,000,000 | ||
| CONTRIBUTION | 16,000,000 | 16,000,000 | 16,000,000 | 16,000,000 | 16,000,000 | ||
| FIXED COST | 6,000,000 | 6,000,000 | 6,000,000 | 6,000,000 | 6,000,000 | ||
| DEPRECIATION -CCA 30% | 2,250,000 | 3,825,000 | 2,677,500 | 1,874,250 | 1,311,975 | ||
| AND CLAIM ONLY 15% IN YEAR 1 | |||||||
| EBIT | 7,750,000 | 6,175,000 | 7,322,500 | 8,125,750 | 8,688,025 | ||
| TAX 35% | 2,712,500 | 2,161,250 | 2,562,875 | 2,844,013 | 3,040,809 | ||
| EAT | 5,037,500 | 4,013,750 | 4,759,625 | 5,281,738 | 5,647,216 | ||
| ADD DEPRECIATION | 2,250,000 | 3,825,000 | 2,677,500 | 1,874,250 | 1,311,975 | ||
| NET CASH FLOW | 5,037,500 | 4,013,750 | 4,759,625 | 5,281,738 | 5,647,216 | ||
| PV FACTOR-16% | 0.862 | 0.743 | 0.641 | 0.552 | 0.476 | ||
| PV VALE UF CASH FLOW-( NET CASH FLOW*PV FACTOR) | 4,342,325 | 2,982,216 | 3,050,920 | 2,915,519 | 2,688,075 | ||
| RECOVERY OF WORKING CAPITAL-90 % OF INITIAL WC | 810,000 | ||||||
| ADD PV VALUE | 385,560 | ||||||
| SCRAP VALE AT THE END OF THE YEAR 5 | 2,000,000 | ||||||
| ADD PV VALE OF SCRAP | 952000 | ||||||
| LESS CAPITAL GAIN | 688025 | ||||||
| GAIN TAX -35% | 240808.75 | ||||||
| PRESENT VALUE NET | 4,342,325 | 2,982,216 | 3,050,920 | 2,915,519 | 3,784,826 | 17,075,806 | |
| NPV | 1,175,806 | ||||||
| NOTE | |||||||
| SINCE THE NPV OF THE PROJECT IS POSITIVE THE PROJECT SHOULD BE ACCEPTABLE | |||||||
| YEAR | DEPRECIATION | ||||||
| 1 | 15,000,000 | 15% | 2250000 | ||||
| 2 | 12,750,000 | 30% | 3825000 | ||||
| 3 | 8,925,000 | 30% | 2677500 | ||||
| 4 | 6,247,500 | 30% | 1874250 | ||||
| 5 | 4,373,250 | 30% | 1311975 | ||||
| SCRAP | 2000000 | ||||||
| GAIN | 688025 |
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