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 $1.91 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 30,000 tents per year at a price of $77 and variable costs of $36 per tent. The fixed costs will be $525,000 per year. The project will require an initial investment in net working capital of $245,000 that will be recovered at the end of the project. The required rate of return is 12.7 percent and the tax rate is 40 percent. What is the NPV?

Answer 1

Initial Investment = $1,910,000
Useful Life = 7 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $1,910,000 / 7
Annual Depreciation = $272,857.14

Initial Investment in NWC = $245,000

Salvage Value = 10% * Initial Investment
Salvage Value = 10% * $1,910,000
Salvage Value = $191,000

After-tax Salvage Value = $191,000 * (1 - 0.40)
After-tax Salvage Value = $114,600

Annual OCF = [(Selling Price per tent - Variable Cost per tent) * Number of tents sold - Fixed Costs] * (1 - tax) + tax * Depreciation
Annual OCF = [($77.00 - $36.00) * 30,000 - $525,000] * (1 - 0.40) + 0.40 * $272,857.14
Annual OCF = $705,000 * 0.60 + 0.40 * $272,857.14
Annual OCF = $532,142.856

Required return = 12.70%

NPV = -$2,155,000 + $532,142.856 * PVA of $1 (12.70%, 7) + $114,600 * PV of $1 (12.70%, 7) + $245,000 * PV of $1 (12.70%, 7)
NPV = -$2,155,000 + $532,142.856 * 4.46422 + $114,600 * 0.43304 + $245,000 * 0.43304
NPV = $376,323.97

NPV of the project is $376,323.97