Question

Earp Brothers, Inc., is considering investing in a machine to produce computer keyboards. The price of the machine will be $995,000, and its economic life is five years. The machine will be fully depreciated by the straight-line method. The machine will produce 40,000 keyboards each year. The price of each keyboard will be $30 in the first year and will increase by 5 percent per year. The production cost per keyboard will be $10 in the first year and will increase by 6 percent per year. The project will have an annual fixed cost of $215,000 and require an immediate investment of $45,000 in net working capital. The corporate tax rate for the company is 34 percent. The appropriate discount rate is 13 percent.

What is the NPV of the investment? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

	Year 1	Year 2	Year 3	Year 4	Year 5
Quantity	40000	40000	40000	40000	40000
Price per unit [Previous Year's Price*(1.05)]	30	31.5	33.075	34.72875	36.4651875
Less: Variable Cost per unit [Previous Year's Cost*(1.06)]	10	10.6	11.236	11.91016	12.6247696
Contribution per unit	20	20.9	21.839	22.81859	23.8404179
Contribution [Contribution per unit*Quantity]	800000	836000	873560	912743.6	953616.716
Less: Fixed Cost	215000	215000	215000	215000	215000
Less: Depreciation [(995000-0)/5]	199000	199000	199000	199000	199000
Profit Before Tax	386000	422000	459560	498743.6	539616.716
Less: Tax@34%	131240	143480	156250.4	169572.824	183469.6834
Profit After Tax [Profit Before Tax-Tax]	254760	278520	303309.6	329170.776	356147.0326
Add: Depreciation	199000	199000	199000	199000	199000
Net Cash Flow	453760	477520	502309.6	528170.776	555147.0326

Initial Outlay = Cost of Equipment + Working Capital	995000 + 45000	1040000
Last year additional cash flow = Salvage Value + Working Capital	0 + 45000	45000
Year	Discounting Factor [1/(1.13^year)]	Cash Flow	PV of Cash Flows (cash flow*discounting factor)
0	1	-1040000	-1040000
1	0.884955752	453760	401557.5221
2	0.783146683	477520	373968.2042
3	0.693050162	502309.6	348125.7498
4	0.613318728	528170.776	323937.0283
5	0.542759936	555147.033	301311.5679
5	0.542759936	45000	24424.19712
		NPV = Sum of PVs	733324.2695 = 733324.27