Question

The Bruin's Den Outdoor Gear is considering a new 7-year project to produce a new tent line. The equipment necessary would cost $1.75 million and be depreciated using straight-line depreciation to a book value of zero. At the end of the project, the equipment can be sold for 10 percent of its initial cost. The company believes that it can sell 28,000 tents per year at a price of $73 and variable costs of $33 per tent. The fixed costs will be $485,000 per year. The project will require an initial investment in net working capital of $229,000 that will be recovered at the end of the project. The required rate of return is 11.6 percent and the tax rate is 35 percent. What is the NPV?

Multiple Choice

• $441,178

• $1,209,473

• $615,031

• $797,752

• $492,246

Answer 1

Calculation of the Depreciation per year:-

Depreciation = 1,750,000 / 7 = 250,000 per year.

Calculation of the after tax of sale of equipment

Equipment sale value =$ 175,000 ( 10% of initial investment)

tax on gain@ 35% = $ 175,000 * 35% = $ 61,250

After tax proceeds fron sale of equipment at end of 7th year = $ 113,750

Calculation of the Operating cash flows per year :-

Particulars	Amount
Sale value	2,044,000	28000*73
Less- Variable cost	924,000	28000*33
Less- Fixed cost	485,000
Less- Depreciation	250,000
Profit before tax	385,000
Less-Tax@35%	134750
Profit after tax	250,250
Add- Depreciation	250,000
Operating cash flows per year	500,250

Calculation of the initial investment :-

Initial investment = purchase price of equipment + Net working capital

= $ 1,750,000 + 229,000

Initial investment = $ 1,979,000

Calculation of present value of cash inflows :-

Year	Operating cash inflows	After tax proceeds from sale of equipment	Recovery of working capital	Total cash inflows	PV [email protected]%	Present value of cf
1	500,250			500,250	0.896057	448,252.688
2	500,250			500,250	0.802919	401,660.115
3	500,250			500,250	0.719461	359,910.497
4	500,250			500,250	0.644679	322,500.445
5	500,250			500,250	0.577669	288,978.894
6	500,250			500,250	0.517625	258,941.661
7	500,250	113,750	229,000	843,000	0.463821	391,001.310
total	2,471,245.611

NPV = Present value of cash inflows - initial investment

= $ 2,471,245.611 - 1,979,000

NPV = $ 492,245.61

NPV = $ 492,246

Option D is correct.