Question

Firm X is considering an investment which will generate the sale of 30,000 units in Year 1. The Unit Price is $100 and COGS for the year is projected to be $ 2,000,000. S,G,& A will be 10% of …Sales and the Interest Expense will be $ 100,000. The Corporate Income Tax Rate is 30% In Year 2, unit sales will be 40,000 units. COGS is projected to be $ 3,000,000 for the second year. All other base data is forecasted to be the same as in Year 1. In Year 3, Net Income is projected to grow at a rate of 10% vs. ..prior year… The project’s Salvage Value will be $ 20,000 and other similar projects generate a 10 % rate of return. If the required initial investment is $ 1,500,000, should this project be pursued ? Why or why not ?

Answer 1

		Present Value (PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Discount Rate=Required return	10%	0.1
		N=Year of Cash Flow
	N	Year	0	1	2	3
	I	Initial Investment	($1,500,000)
	A	Unit Price		$100	$100	$100
	B	Unit Sales		30,000	40000
	C=A*B	Sales Revenue		$3,000,000	$4,000,000
	D	Cost of Goods sold		$2,000,000	$3,000,000
	E=C*10%	S,G & A expenses		$300,000	$300,000
	F	Interest expense		$100,000	$100,000
	G=C-D-E-F	Income before taxes		$600,000	$600,000
	H=G*30%	Tax expenses		$180,000	$180,000
	J=G-H	Net Income		$420,000	$420,000	$462,000	(1.1*420000)
	K	Salvage Value				$20,000
	L=I+J+K	NET CASH FLOW	($1,500,000)	$420,000	$420,000	$482,000	SUM
	PV=L/(1.1^N)	Present Value of Net Cash Flow	($1,500,000)	$381,818	$347,107	$362,134	($408,941)
	NPV=sum of PV	Net Present Value of the project	($408,941)
		NO, This project should not be pursued
		NPV is negative
		It does not produce required return