Question

Norister Inc. is considering introducing a new product line. This will require the purchase of new fixed assets of $2.4 million. The company estimates that demand for the new product will be approximately 15,000 units per year, with a price per unit of $100. The variable cost of producing each unit of the product is $35, and fixed costs per year will be $100,000. Demand for the product is expected to remain constant for six years, after which both demand and production will cease, and the associated fixed assets will have no salvage value. Depreciation on the fixed assets will be straight-line to zero. The company’s marginal tax rate is 35%, and the required return on the project is 13%. Due to forecasting risk, the company estimates that price per unit, variable cost, fixed costs, and quantity sold could vary by ±10%, ±15%, ±5%, and ±10%, respectively. What is the project’s net present value in the best-case scenario?

Select one: a. $1,543,413 b. $1,353,424 c. $1,043,502 d. $368,020 e. $103,677

Answer 1

Calculation of NPV in the best case Scenario
Particulars	0	1	2	3	4	5	6
Initial Investment
Cost of New fixed Asset (A)	-2400000
Operating Cash Flows
Sales Units (B = 15,000 * (1+10%))		16500	16500	16500	16500	16500	16500
Annual Sales (C = B* $100 * (1+10%))		1815000	1815000	1815000	1815000	1815000	1815000
Varibale Costs (D = B*$35 * (1-15%))		490875	490875	490875	490875	490875	490875
Fixed Costs (E = $100,000 * (1-5%))		95000	95000	95000	95000	95000	95000
Depreciation (F = $2,400,000 / 6 years)		400000	400000	400000	400000	400000	400000
Profit Before Tax (G = C-D-E-F)		829125	829125	829125	829125	829125	829125
Tax @35% (H = G*35%)		290193.75	290193.75	290193.75	290193.75	290193.75	290193.75
Profit After Tax (I = G-H)		538931.25	538931.25	538931.25	538931.25	538931.25	538931.25
Add back Depreciation (J = F)		400000	400000	400000	400000	400000	400000
Net Operating Cash Flows (K = I+J)		938931.25	938931.25	938931.25	938931.25	938931.25	938931.25
Total Cash Flows (L = A+K)	-2400000	938931.25	938931.25	938931.25	938931.25	938931.25	938931.25
Discount Factor @13% (M) 1/(1+13%)^n n=0,1,2,3,4,5,6	1	0.8849558	0.7831467	0.6930502	0.6133187	0.5427599	0.4803185
Discounted Cash Flows (N = L*M)	-2400000	830912.61	735320.89	650726.46	575864.12	509614.27	450986.08
Net Present Value	1353424.42
Therefore, project's net present value in best case scenario is $1,353,424
Option b is correct