Question

HuaWei Ltd manufactures a variety of electrical equipment. Project P30 is a new product that HuaWei is considering introducing to the market. The company’s finance team has collected a lot of information about the project below: (Note: You may or may not need to use all this informati • The company paid a consulting firm $600,000 last year for a test marketing analysis, as part of the evaluation. • The HuaWei will have to purchase a new machine to produce the electrical products. The machine has an upfront cost of $5,000,000 at Year 0. • The machine will be depreciated on a straight-line basis over 4 years to a zero balance. The company expects that the machine will be sold for $60,000 when the project is completed at Year 4. • At Year 0, the net working capital will increase by $150,000. In the final year of the project (Year 4), net working capital will be fully recovered. • Forecasted sales quantity, selling price and production costs of Project ABC are presented below. Year 1 Year 2 Year 3 Year 4 Sales quantity 3,000,000 units 3,000,000 units 3,000,000 units 3,000,000 units Selling price $3 per unit $3 per unit $3 per unit $3 per unit Fixed cost of production $2,000,000 per year $2,000,000 per year $2,000,000 per year $2,000,000 per year Variable cost of production $2 per unit $2 per unit $2 per unit $2 per unit • The company’s tax rate is 35 percent. • The project’s cost of capital is estimated to be 25 percent per annum. a. Calculate the net present value of the proposed project (see overpage for a template) b. Should the project be accepted or rejected?

Answer 1

Tax rate		35%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4		Total
Cost		$    5,000,000	$       5,000,000	$       5,000,000	$                 5,000,000
Dep Rate		25.00%	25.00%	25.00%	25.00%
Depreciation	Cost * Dep rate	$    1,250,000	$       1,250,000	$       1,250,000	$                 1,250,000		$    5,000,000
Calculation of after-tax salvage value
Cost of machine			$       5,000,000
Depreciation			$       5,000,000
WDV	Cost less accumulated depreciation	$                    -
Sale price			$            60,000
Profit/(Loss)	Sale price less WDV		$            60,000
Tax	Profit/(Loss)*tax rate		$            21,000
Sale price after-tax	Sale price less tax		$            39,000
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4
No of units		3,000,000	3,000,000	3,000,000	3,000,000
Selling price		$             3.00	$                3.00	$                3.00	$                          3.00
Operating ost		$             2.00	$                2.00	$                2.00	$                          2.00
Sale		$    9,000,000	$       9,000,000	$       9,000,000	$                 9,000,000
Less: Operating Cost		$    6,000,000	$       6,000,000	$       6,000,000	$                 6,000,000
Contribution		$    3,000,000	$       3,000,000	$       3,000,000	$                 3,000,000
Less: Fixed cost		$    2,000,000	$       2,000,000	$       2,000,000	$                 2,000,000
Less: Depreciation		$    1,250,000	$       1,250,000	$       1,250,000	$                 1,250,000
Profit before tax (PBT)		$     (250,000)	$         (250,000)	$         (250,000)	$                   (250,000)
Tax@35%	PBT*Tax rate	$       (87,500)	$           (87,500)	$           (87,500)	$                     (87,500)
Profit After Tax (PAT)	PBT - Tax	$     (162,500)	$         (162,500)	$         (162,500)	$                   (162,500)
Add Depreciation	PAT + Dep	$    1,250,000	$       1,250,000	$       1,250,000	$                 1,250,000
Cash Profit after-tax		$    1,087,500	$       1,087,500	$       1,087,500	$                 1,087,500
Calculation of NPV
						25.00%
Year		Capital	Working capital	Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0		$ (5,000,000)	$         (150,000)		$                (5,150,000)	1.0000	$ (5,150,000)
1				$       1,087,500	$                 1,087,500	0.8000	$       870,000
2				$       1,087,500	$                 1,087,500	0.6400	$       696,000
3				$       1,087,500	$                 1,087,500	0.5120	$       556,800
4		$         39,000	$          150,000	$       1,087,500	$                 1,276,500	0.4096	$       522,854
					Net Present Value		$ (2,504,346)