Question

Chips Inc. has come up with a new product. Chips paid $127,668 for a marketing survey to determine the viability of the product. It is felt that the product will generate sales of $768,938 per year. The fixed costs associated with this will be $189,339 per year, and variable costs will amount to 29 percent of sales. The equipment necessary for production of the product will cost $843,852 and will be depreciated in a straight-line manner for the four years of the product life. This is the only initial cost for the production. Chips is in a 39 percent tax bracket and has a required return of 13 percent. Calculate the NPV. Answer in $ to two decimals.

Answer 1

Computation of Annual Cash flows

S.No	Particulars	Amount
A	Sales	$768,938
B	Variable Cost( Sales * 29%)	$222,992.02
C	Fixed Cost	$189,339
D	Depreciation	$210,963.00
E	Profit Before Tax( A-B-C-D)	$145,643.98
F	Taxes @ 39%	$56,801.15
G	Profit After Tax( E-F)	$88,842.83
H	Depreciation	$210,963.00
I	Annual Cash flow ( G+H)	$299,805.83

Computation of Depreciation

Depreciation =( Cost - salvage value)/ Expected useful life

= ( $ 843852-0) /4

= $ 210963

Computation of Present value of future cash flows

Year	Annual Cash flow	Disc @ 13%	Discounted Cash flows
1	$299,805.83	0.8850	$265,314.89
2	$299,805.83	0.7831	$234,791.94
3	$299,805.83	0.6931	$207,780.48
4	$299,805.83	0.6133	$183,876.53
	Total		$891,763.84

Computation of Net Present value

Particulars	Amount
PV of the Cash inflows	$891,763.84
Less: Initial investment	($843,852)
Net Present value	$47,911.84

Since NPV is positive, we can accept the Project.

Note: The amount incurred on Marketing Survey is treated as Sunk Cost. Eventhough the Project has been started or not, this amount is already incurred. Hence this amount should not be considered for Decision making.

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