Question

Use the following information to answer the 8 questions (filling in the blanks) that follow it. When answering the questions, DO NOT use dollar signs, USE commas to separate thousands, DO NOT use parenthesis to denote negative numbers, USE the negative sign and place it in front of first digit of your answer when your answer is a negative number. Round to the nearest dollar (do not enter decimals). For example, if your answer is -$1,245,300.40 then enter -1,245,300

RET Inc. currently has one product, low-priced stoves. RET Inc. has decided to sell a new line of medium-priced stoves. Sales revenues for the new line of stoves are estimated at $30 million a year. Variable costs are 75% of sales. The project is expected to last 10 years. Also, non-variable costs are $4,000,000 per year. The company has spent $1,000,000 in research and a marketing study that determined the company will lose (cannibalization) $10 million in sales a year of its existing low-priced stoves. The production variable cost of the existing low-priced stoves is $8 million a year.

The plant and equipment required for producing the new line of stoves costs $10,000,000 and will be depreciated down to zero over 20 years using straight-line depreciation. It is expected that the plant and equipment can be sold (salvage value) for $6,000,000 at the end of 10 years. The new stoves will also require today an increase in net working capital of $2,000,000 that will be returned at the end of the project.

The tax rate is 40 percent and the cost of capital is 10%.

1. What is the initial outlay (IO) for this project?

2. What is the annual Earnings before Interests, and Taxes (EBIT) for this project?                                    

3. What is the annual net operating profits after taxes (NOPAT) for this project?

4. What is the annual incremental net cash flow (operating cash flow: OCF) for this project?

5. What is the remaining book value for the plant at equipment at the end of the project?

6. What is the cash flow due to tax on salvage value for this project? Enter a negative # if it is a tax gain. For example, if your answer is a tax on capital gains of $3,004.80 then enter   -3,005 ; if your answer is a tax shelter from a capital loss of $1,000,20 then enter 1,000  

7. What is the project's cash flow for year 10 for this project?

8. What is the Net Present Value (NPV) for this project? In order to avoid the system marking your answer as wrong due to rounding errors, please round your answer to the nearest THOUSAND and do not enter decimals, do not enter $ sign, and use - sign instead of parenthesis. For example, if your answer is -$1,245,823.60 then enter -1,246,000

Answer 1

1) Initial outlay = Purchase of equipment + Working capital requirements

= 10,000,000 + 2,000,000

= 12,000,000

2) Statement showing Annual earning before Interests, and Taxes

Particulars	Amount
Sale of medium-priced stoves	30000000
Less: Variable costs (75% x 30,000,000)	22500000
Less : Contribution loss from existing low-priced stoves (10,000,000-8,000,000)	2000000
Less : Fixed cost	4000000
Less : Depreciation (10,000,000/20)	500000
EBIT	1000000

Thus EBIT = 1,000,000

3) Statement showing annual net operating profits after taxes (NOPAT)

Particulars	Amount
EBIT	1000000
Less Taxes @ 40%	400000
NOPAT	600000

Thus NOPAT = 600,000

4) Statement showing annual incremental net cash flow

Particulars	Amount
NOPAT	600000
Add : Depreciaton	500000
OCF	1100000

Thus OCF = 1100,000

5) Remaining book value for the plant at equipment at the end of the project = Cost of equipment - (Annual Depreciation x 10)

= 10,000,000 - (500000 x 10)

= 10,000,000 - 5000,000

=5,000,000

6) Here salavage value of equipment after 10 years = 6,000,000 and book value = 5,000,000

Thus there is profit of 1000,000 (6,000,000-5,000,000)

Thus tax on above profit = 1,000,000 x 40%

=-400,000

7) Project's cash flow for year 10 for this project = OFC for year 10 + Release of Working capital + Salvage value of equipment - Tax on sale of equipment

= 1,100,000 + 2,000,000 + 6,000,000 - 400,000

= 8,700,000

8) Statement showing NPV

Particulars	1 to 9	10	Total
Sale of medium-priced stoves	30000000	30000000
Less: Variable costs (75% x 30,000,000)	22500000	22500000
Less : Contribution loss from existing low-priced stoves (10,000,000-8,000,000)	2000000	2000000
Less : Fixed cost	4000000	4000000
Less : Depreciation (10,000,000/20)	500000	500000
EBIT	1000000	1000000
Less Taxes @ 40%	400000	400000
NOPAT	600000	600000
Add : Depreciaton	500000	500000
OCF	1100000	1100000
Add: Release of WC		2000000
Add: Salvage value of equipment		5600000
Total cash flow	1100000	8700000
PVIFA(10%,9 years)	5.7590
PVIF(10%,10 th year)		0.3855
PV	6334926	3354227	9689153
Less : Initial Investment			12000000
NPV			-2310847

Thus NPV = -2,311,000