Question

The following table presents sales forecasts for Golden Gelt Giftware. The unit price is $20. The unit cost of the giftware is $10.

  

Year	Unit Sales
1	32,000
2	40,000
3	14,000
4	8,000
Thereafter	0

It is expected that net working capital will amount to 20% of sales in the following year. For example, the store will need an initial (Year 0) investment in working capital of .20 × 32,000 × $20 = $128,000. Plant and equipment necessary to establish the giftware business will require an additional investment of $210,000. This investment will be depreciated using MACRS and a 3-year life. After 4 years, the equipment will have an economic and book value of zero. The firm’s tax rate is 35%. What is the net present value of the project? The discount rate is 10%. Use the MACRS depreciation schedule. (Do not round intermediate calculations. Round your answer to the nearest whole dollar amount.)

Answer 1

Initial investment ($)	2,10,000
Unit cost ($)	10
Unit price ($)	20
WC	20% of next year's sales
Tax-rate	35%
Discount rate	10%

MACRS schedule:

Year (n)	Adjusted basis	Depreciation rate	Depreciation (dep rate*initial investment)	Cumulative	Ending BV (Adj.basis-dep.)
1	2,10,000	33.33%	69,993	69,993	1,40,007
2	1,40,007	44.45%	93,345	1,63,338	46,662
3	46,662	14.81%	31,101	1,94,439	15,561
4	15,561	7.41%	15,561	2,10,000	-

Operating Cash Flow calculation:

Formula	Year (n)	1	2	3	4
	Unit sales (U)	32,000	40,000	14,000	8,000
(U*unit price)	Total sales (S)	6,40,000	8,00,000	2,80,000	1,60,000
(U*unit cost)	Total cost ('C)	3,20,000	4,00,000	1,40,000	80,000
(S-C)	EBITDA	3,20,000	4,00,000	1,40,000	80,000
From the MACRS schedule	Depreciation (D)	69,993	93,345	31,101	15,561
(EBITDA-D)	EBIT	2,50,007	3,06,655	1,08,899	64,439
(35%*EBIT)	Tax @35%	87,502.45	1,07,329.25	38,114.65	22,553.65
(EBIT-Tax)	Net income	1,62,504.55	1,99,325.75	70,784.35	41,885.35
	Add: depreciation	69,993	93,345	31,101	15,561
(Net income + D)	Operating Cash Flow (OCF)	2,32,497.55	2,92,670.75	1,01,885.35	57,446.35

Working Capital calculation:

Formula	Year (n)	0	1	2	3	4
	Working capital (WC)	1,28,000	1,60,000	56,000	32,000	0
(Year(n)WC - Year(n-1)WC)	Change in WC	-1,28,000	-32,000	1,04,000	24,000	32,000

NPV calculation:

Formula	Year (n)	0	1	2	3	4
	Initial investment (II)	-2,10,000
	OCF		2,32,497.55	2,92,670.75	1,01,885.35	57,446.35
	Change in WC (CWC)	-1,28,000	-32,000	1,04,000	24,000	32,000
(II + OCF + CWC)	Total cash flows (CF)	-3,38,000	2,00,498	3,96,671	1,25,885	89,446
1/(1+d)^n	Discount factor @10%	1.000	0.909	0.826	0.751	0.683
(CF*discount factor)	Discounted CF	-3,38,000.00	1,82,270.50	3,27,827.07	94,579.53	61,093.06
Sum of all discounted CFs	NPV	3,27,770.15

NPV = $327,770