Question

Earp Brothers, Inc., is considering investing in a machine to produce computer keyboards. The price of the machine will be $985,000, and its economic life is five years. The machine will be fully depreciated by the straight-line method. The machine will produce 30,000 keyboards each year. The price of each keyboard will be $30 in the first year and will increase by 6 percent per year. The production cost per keyboard will be $10 in the first year and will increase by 7 percent per year. The project will have an annual fixed cost of $205,000 and require an immediate investment of $35,000 in net working capital. The corporate tax rate for the company is 35 percent. The appropriate discount rate is 13 percent.
  
What is the NPV of the investment?

Answer 1

Particulars	1	2	3	4	5
Sales	900,000.00	954,000.00	1,011,240.00	1,071,914.40	1,136,229.26
Less: variable costs	300,000.00	321,000.00	343,470.00	367,512.90	393,238.80
Contribution	600,000.00	633,000.00	667,770.00	704,401.50	742,990.46
Less: rent lost	(205,000.00)	(205,000.00)	(205,000.00)	(205,000.00)	(205,000.00)
Incremental cash flows	395,000.00	428,000.00	462,770.00	499,401.50	537,990.46

Ref	Particulars		Year 1	Year 2	Year 3	Year 4	Year 5
a	Operating cash flow		$        395,000.00	$            428,000.00	$     462,770.00	$     499,401.50	$     537,990.46
	Salvage value						$                      -
b	Depreciation		$      (328,333.33)	$           (328,333.33)	$    (328,333.33)	$    (328,333.33)	$    (328,333.33)
c=a-b	Profit before tax		$          66,666.67	$               99,666.67	$     134,436.67	$     171,068.17	$     209,657.13
	Profit after tax		$          43,333.33	$               64,783.33	$        87,383.83	$     111,194.31	$     136,277.13
	Add depreciation		$        328,333.33	$            328,333.33	$     328,333.33	$     328,333.33	$     328,333.33
	Add: working capital		$                        -	$                             -	$                      -	$                      -	$        35,000.00
	Free cash flow		$        371,666.67	$            393,116.67	$     415,717.17	$     439,527.64	$     499,610.47
d	Present value factor@ 13.0%		0.884955752	0.783146683	0.693050162	0.613318728	0.542759936
e=c*d	Present value of annual cashflows		$        328,908.55	$            307,868.01	$     288,112.85	$     269,570.53	$     271,168.54
	Total present value of annual cash inflows		$    1,465,628.50
	Investment:
	Equipment		$      (985,000.00)
	Working capital		$        (35,000.00)
	NPV		$        445,628.50

NPV is $445,628.50

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