Question

Sony International has an investment opportunity to produce a new stereo HDTV. The required investment on January 1 of this year is $200 million. The firm will depreciate the investment to zero using the straight-line method over four years. The investment has no resale value after completion of the project. The firm is in the 34 percent tax bracket. The price of the product will be $485 per unit, in real terms, and will not change over the life of the project. Labor costs for Year 1 will be $16.20 per hour, in real terms, and will increase at 3 percent per year in real terms. Energy costs for Year 1 will be $3.80 per physical unit, in real terms, and will increase at 2 percent per year in real terms. The inflation rate is 6 percent per year. Revenues are received and costs are paid at year-end. Refer to the following table for the production schedule: Year 1 Year 2 Year 3 Year 4 Physical production, in units 190,000 200,000 220,000 210,000 Labor input, in hours 1,195,000 1,275,000 1,435,000 1,355,000 Energy input, in physical units 285,000 305,000 325,000 310,000 The real discount rate for the company is 5 percent. Calculate the NPV of this project. (Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 1,234,567.89.) NPV $

Answer 1

First: Since the real rates are given so now adjustments for the inflation is required in the calculation for the NPV.

1) Calculation of Total Revenue:

Assuming: Units produced are the sold units.

Years	1	2	3	4
Unit sales	1,90,000	2,00,000	2,20,000	2,10,000
Sales price	$             485.00	$            485.00	$              485.00	$              485.00
Total Revenue	$ 9,21,50,000.00	$9,70,00,000.00	$10,67,00,000.00	$10,18,50,000.00

2) Calculation of Total Labour cost:

Years	1	2	3	4
Labour Hours	11,95,000.00	12,75,000.00	14,35,000.00	13,55,000.00
Labour cost per hour	$               16.20	$              16.69	$                17.19	$                17.70
Total Labour cost	$ 1,93,59,000.00	$2,12,74,650.00	$ 2,46,62,742.30	$ 2,39,86,450.38

3) Calculation of Total Energy cost:

Years	1	2	3	4
Physical units	2,85,000.00	3,05,000.00	3,25,000.00	3,10,000.00
Energy cost per unit	$                 3.80	$                3.88	$                  3.95	$                  4.03
Total Energy cost	$    10,83,000.00	$   11,82,180.00	$     12,84,894.00	$     12,50,103.02

4) Calculation of the Cah Flows:

5) Calculation of PV of project @WACC 5%:

NPV = -$200,000,000 + $64,327,280/(1.05^1) + $63,048,655/(1.05^2) + $60,797,933/(1.05^3) + $61,229,412/(1.05^4)

= $21,344,194.82