Question

The Swiss Lakes Pen Company (SLPC) has decided to start a new project manufacturing gardening tools, an entirely new area for the company. The company is considering a 4-year project in which revenues will be €6 million per year (constant for 4 years), manufacturing costs will be 40% of revenues, SGA will be €1.2 million per year (constant for four years) and the capital investment required will be €3 million (zero value after four years). This investment can be depreciated on a straight-line basis over four years and the company’s tax rate is 35%.

1. Calculate the incremental free cash flows (FCFs) for this project.

2. Using NVP, the company employs a discount rate of 12.8%,should the company go ahead with the project?

Answer 1

Based on given data, pls find below workings on Cash Flows and NPV;

Based on the below workings, the NPV is positive $ 2443578 and hence this project is feasible and recommended for investment.

Computation:

Computation of Net Present Value (NPV) based on the Discounted Cash flows; The Discounting factor is computed based on the formula: For year 0, the discounting factor is 1; For Year 1, it is computed as = Year 0 factor /(1+discounting factor%) ; Year 2 = Year 1 factor/(1+discounting factor %) and so on;

Next, the cashflows need to be multiplied with the respective years' discounting factor, to arrive at the discounting cash flows;

The total of all the discounted cash flows is equal to its respective Project NPV of the Cash Flows;

EXCEL in $ Million:

EXCEL WITH FORMULAE:

Project ($) Year o Year 1 Year 2 Year 3 Year 4 30,00,000 Cost of New Machine Revenues Manufacturing Costs SG & A Costs Depreciation EBIT Tax @ 35% Net Income 60,00,000 24,00,000 12,00,000 7,50,000 16,50,000 5,77,500 10,72,500 60,00,000 24,00,000 12,00,000 7,50,000 16,50,000 5,77,500 10,72,500 60,00,000 24,00,000 12,00,000 7,50,000 16,50,000 5,77,500 10,72,500 60,00,000 24,00,000 12,00,000 7,50,000 16,50,000 5,77,500 10,72,500 -30,00,000 1 Cash Flows (Net Income + Depreciation) Discounting Factor Discounted Cash Flow Cumulative Discounted Cash Flow 18,22,500 0.8865 16,15,691 -13,84,309 18,22,500 0.7859 14,32,351 48,042 18,22,500 0.6967 12,69,814 13,17,856 18,22,500 0.6177 11,25,722 24,43,578 -30,00,000 -30,00,000 NPV 24,43,578 Discounting Factor 12.80%