Question

Consider the following project for Hand Clapper, Inc. The company is considering a 4-year project to manufacture clap-command garage door openers. This project requires an initial investment of $16.3 million that will be depreciated straight-line to zero over the project’s life. An initial investment in net working capital of $1,030,000 is required to support spare parts inventory; this cost is fully recoverable whenever the project ends. The company believes it can generate $13.5 million in pretax revenues with $5.4 million in total pretax operating costs. The tax rate is 38 percent, and the discount rate is 13 percent. The market value of the equipment over the life of the project is as follows: Year Market Value ($ millions) 1 $ 14.30 2 11.30 3 8.80 4 0.00 a. Assuming the company operates this project for four years, what is the NPV? (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 $ b-1 Compute the project NPV assuming the project is abandoned after only one year. (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 $ b-2 Compute the project NPV assuming the project is abandoned after only two years. (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 $ b-3 Compute the project NPV assuming the project is abandoned after only three years. (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

Solution:

a)Calculation of NPV

i)Initial Investment

=Cost of project+Working capital requirement

=$16.3 million+1.03 million=$17.33 million

ii)Annual depreciation=$16.3/4=$4075,000

iii)Annual after tax cash flows

=(Pretax revenue-Pretax cost)*(1-tax rate)+Depreciation*tax rate

=($13500,000-$5400,000)*(1-0.38)+$4075,000*38%

=$5022,000+$1548500

=$6,570,500

iv)After tax sale proceed

=Sale Proce(1-tax rate)

=Since the sale proceed at the end of 4th year is nil,hence there is no after tax sale proceed

=0

v)NPV

NPV=(Present value of Annual after tax cash flows+Present value of working capital recovery)-initial investment

=($6,570,500*PVAF@13% for 4 year+$1030,000*PVIF@13% for 4th year)-$17330,000

=($6,570,500*2.9745+$1030,000*0.6133)-$17330,000

=$2,845,651.25

Thus NPV is 2,845,651.25

b-1)If the project is abandoned after onlyone year,then there is need to calculate after tax sale proceed;

After tax sale proceed=Sale Proceed-(Sale Price-Book Value)*tax rate)

=$14300,000-[$14300,000-($16300,000-$4075,000)]*38%

=$14300,000-$788,500=$13511,500

NPV

=Present value of Annual after tax cash flows+Present value of after tax sale proceed+Present value of working capital recovery)-initial investment

=(6,570,500+13511,500+$1030,000)*PVIF@13% for 1 year-17330,000

=1353,185.84

Thus NPV is 1353,185.84

b-2)After tax sale proceed=$11300,000-[(11300,000-($16300,000-$4075,000-$4075000)]*38%

=$11300,000-$1197000

=$10103,000

NPV is;

=Present value of Annual after tax cash flows+Present value of after tax sale proceed+Present value of working capital recovery)-initial investment

=[6,570,500*PVAF for 2 year@13%+(10103,000+1030,000)*PVIF@13% for 2 years]-17330,000

=(10960,267.05+8718772.03)-17330,000

=2,349,039.08

Thus NPV is 2,349,039.08

b-3.You can calculate the NPV in similar manner.