Question

The Bruin's Den Outdoor Gear is considering a new 6-year project to produce a new tent line. The equipment necessary would cost $1.37 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 15 percent of its initial cost. The company believes that it can sell 25,500 tents per year at a price of $68 and variable costs of $28 per tent. The fixed costs will be $435,000 per year. The project will require an initial investment in net working capital of $209,000 that will be recovered at the end of the project. The required rate of return is 11.1 percent and the tax rate is 40 percent. What is the NPV?

a) $660,397

b) $402,852

c) $463,633

d) $561,495

e) $968,299

Answer 1

Time line		0	1	2	3	4	5	6
Cost of new machine		-1370000
Initial working capital		-209000
=Initial Investment outlay		-1579000
Unit sales			25500	25500	25500	25500	25500	25500
Profits	=no. of units sold * (sales price - variable cost)		1020000	1020000	1020000	1020000	1020000	1020000
Fixed cost			-435000	-435000	-435000	-435000	-435000	-435000
-Depreciation	Cost of equipment/no. of years		-228333.3	-228333.33	-228333.3	-228333.3	-228333.3	-228333.3
=Pretax cash flows			356666.67	356666.667	356666.67	356666.67	356666.6667	356666.67
-taxes	=(Pretax cash flows)*(1-tax)		214000	214000	214000	214000	214000	214000
+Depreciation			228333.33	228333.333	228333.33	228333.33	228333.3333	228333.33
=after tax operating cash flow			442333.33	442333.333	442333.33	442333.33	442333.3333	442333.33
reversal of working capital								209000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)							123300
+Tax shield on salvage book value	=Salvage value * tax rate							0
=Terminal year after tax cash flows								332300
Total Cash flow for the period		-1579000	442333.33	442333.333	442333.33	442333.33	442333.3333	774633.33
Discount factor=	(1+discount rate)^corresponding period	1	1.111	1.234321	1.3713306	1.5235483	1.692662196	1.8805477
Discounted CF=	Cashflow/discount factor	-1579000	398139.81	358361.669	322557.76	290331.01	261324.0459	411919
NPV=	Sum of discounted CF=	463633.304