In: Finance
Monhegan Computers is considering whether to begin offering customers the option to have their old personal computers recycled when they purchase new systems. The recycling system would require Monhegan to invest $650,000 in the grinders and magnets used in the recycling process (that is at t=0). The company estimates that for each system it recycles, it would generate $1.75 in incremental revenues from the sale of scrap metal and plastics. The recycled computers will cost the firm nothing, but it will cost the firm $0.25 per unit to dispose of the toxic elements from the recycled computer. The firm expects to use the recycling equipment for five years, and at t=5 sell the recycling equipment for $30,000. The machinery will be depreciated at the five-year MACRS depreciation schedule. (The MACRS depreciation schedule for a five year life is: year 1--20%, year 2--32%, year 3—19.2%, year 4—11.52%, year 5—11.52%, year 6—5.76%. Note that a five year life lasts 6 years because of the half year convention for the first year, but the machinery is sold at t=5.) During the life of the machine no new capital expenditures or investments in working capital will be required. Monhegan estimates that in the first year of the recycling project, it could recycle 110,000 PCs and that this number will grow by 20% per year over the remaining four-year life of the recycling equipment. Monhegan uses a 14% discount rate to analyze capital expenditures and pays taxes equal to 30%. You must calculate the PFCFs. What is the project’s NPV?
Initial Investment = Cost of recycling system = 650000
Depreciation under MACRS = rate x initial investment
Calculating depreciation under MACRS | |||||
Year | 1 | 2 | 3 | 4 | 5 |
Rate | 20% | 32% | 19.20% | 11.52% | 11.52% |
Depreciation | 130000.00 | 208000.00 | 124800.00 | 74880.00 | 74880.00 |
Calculating incremental revenues and incremental costs
As no of PCs sold each year increase by 20%, therefore
No of PCs sold in year 1 = 110000 ,
For other year 2 to 5 , no of PC sold in a year = no of PC sold in previous year x ( 1 + 20%)
Incremental Revenue for year = no of pc sold in a year x incremental revenue per pc from sale of scrap
Year | 1 | 2 | 3 | 4 | 5 |
No of PC sold | 110000 | 132000 | 158400 | 190080 | 228096 |
Incremental revenue per PC from sale of scrap | 1.75 | 1.75 | 1.75 | 1.75 | 1.75 |
Incremental revenue for a year | 192500 | 231000 | 277200 | 332640 | 399168 |
Incremental cost for a year = no of pc sold x incremental cost per pc to dispose a computer
Year | 1 | 2 | 3 | 4 | 5 |
No of PC sold | 110000 | 132000 | 158400 | 190080 | 228096 |
Incremental cost per PC for disposal | 0.25 | 0.25 | 0.25 | 0.25 | 0.25 |
Incremental cost for a year | 27500 | 33000 | 39600 | 47520 | 57024 |
Calculation of after tax operating cash flows
After tax operating cash flow for a year 1 to 5 =EBIT(1-tax rate) + depreciation = (incremental revenue - incremental cost - depreciation) (1-tax rate) + depreciation
Calculating after tax operating cash flow | |||||
Year | 1 | 2 | 3 | 4 | 5 |
Incremental Revenue | 192500.00 | 231000.00 | 277200.00 | 332640.00 | 399168.00 |
Incremental Cost | 27500.00 | 33000.00 | 39600.00 | 47520.00 | 57024.00 |
Depreciation | 130000.00 | 208000.00 | 124800.00 | 74880.00 | 74880.00 |
EBIT | 35000.00 | -10000.00 | 112800.00 | 210240.00 | 267264.00 |
EBIT(1-tax rate) | 24500.00 | -7000.00 | 78960.00 | 147168.00 | 187084.80 |
Plus: Depreciation | 130000.00 | 208000.00 | 124800.00 | 74880.00 | 74880.00 |
After tax operating cash flow | 154500.00 | 201000.00 | 203760.00 | 222048.00 | 261964.80 |
Calculating terminal cash flow
Book value of equipment at the end of five years = Initial investment - sum of depreciation for first five years
= 650000 - (130000 + 208000 + 124800 + 74880 + 74880) = 650000 - 612560 = 37440
Terminal cash flow =Salvage value of equipment at end of 5 years - tax paid on sale = Salvage value at end of 5 years - tax rate(Salvage value at end of 5 years - Book value at the end of 5 years)
Terminal cash flow = 30000 - 30%(30000 - 37440) = 30000 - (-2232) = 30000 + 2232 = 32232
Calculating PFCF
Calculating Projected Free cash flow (PFCF) | |||||
Year | 1 | 2 | 3 | 4 | 5 |
After tax operating cash flow (a) | 154500.00 | 201000.00 | 203760.00 | 222048.00 | 261964.80 |
Termnal Cash flow (b) | 32232.00 | ||||
PFCF or Net Cash Flow = (a) + (b) | 154500.00 | 201000.00 | 203760.00 | 222048.00 | 294196.80 |
NPV of the project = - initial investment + sum of present values of PFCF from year 1 to 5
= -650000 + 154500/(1+14%) + 201000/(1+14%)2 + 203760/(1+14%)3 + 222048/(1+14%)4 + 294196.80/(1+14%)5
= - 650000 + 135526.32 + 154662.97 + 137532.20 + 131470.24 + 152796.60 = 61988.33
Therefore NPV of the project = 61988.33