Question

United Pigpen is considering a proposal to manufacture high-protein hog feed. The company spent $20,000 to do market research on potential products. The project would require use of an existing warehouse, which is currently rented out to a neighboring firm. The next year’s rental charge on the warehouse is $100,000 (after taxt), and thereafter, the rent is expected to grow in line with inflation at 4% a year. In addition to using the warehouse, the proposal envisages an investment in plant and equipment of $1.2 million. The company has to pay $20,000 for installation cost. The machine could be depreciated for tax purposes straight-line over 10 years. However, Pigpen expects to terminate the project at the end of 8 years and to resell the plant and equipment in year 8 for $400,000. To finance the project, the company estimate and fine that they need to borrow $400,000 that will cost firm $40,000 of interest each year. Finally, the project requires an immediate investment in working capital of $350,000. Thereafter, working capital is forecasted to be 10% of sales in each of years 1 through 7. Year 1 sales of hog feed are expected to be $4.2 million, and thereafter, sales are forecasted to grow by 5% a year, slightly faster than the inflation rate. Manufacturing costs are expected to be 90% of sales, and profits are subject to tax at 35%. The cost of capital is 12%.

What is the NPV of Pigpen’s project?

Answer 1