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Werton Corporation has developed a new processor that would be used by many specialty companies. It...
- Werton Corporation has developed a new processor that would be used by many specialty companies. It would cost $29 million at Year 0 to buy the equipment necessary to manufacture the facility. The project would require net working capital in Year 0 of 5,500,000 and then 5 percent of revenue in each of the operational years to follow (Year1 to Year 4). The processor would sell for $83,000 per unit, and Werton believes that variable costs would amount to $61,500 per unit. The company’s non-variable costs (incremental cost) would be $1.6 million at Year 1. After Year 1, the sales price , variable costs and incremental costs are expected to grow at the inflation rate of 2% per year. The processor project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 years. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. The firm believes it could sell 600 units per year. The equipment would be depreciated over a 3-year period, using rates (34%, 33%, and 33%). The estimated market value (salvage value) of the equipment at the end of the project’s 4-year life is $300,000, but environmental close down costs are estimated at $2,100,000 (these cash flows along with WC recovery should occur in Year 5). Werton’s federal-plus-state tax rate is 30%. Its cost of capital is 10% for average-risk projects. Should Werton invest in the project (i.e., calculate the NPV).
Solutions
Expert Solution
| Tax rate | 30% | ||||||||
| Calculation of annual depreciation | |||||||||
| Depreciation | Year-1 | Year-2 | Year-3 | Total | |||||
| Cost | $ 29,000,000 | $ 29,000,000 | $ 29,000,000 | ||||||
| Dep Rate | 34.00% | 33.00% | 33.00% | ||||||
| Depreciation | Cost * Dep rate | $ 9,860,000 | $ 9,570,000 | $ 9,570,000 | $ 29,000,000 | ||||
| Calculation of after-tax salvage value | |||||||||
| Cost of machine | $ 29,000,000 | ||||||||
| Depreciation | $ 29,000,000 | ||||||||
| WDV | Cost less accumulated depreciation | $ - | |||||||
| Sale price | $ 300,000 | ||||||||
| Profit/(Loss) | Sale price less WDV | $ 300,000 | |||||||
| Tax | Profit/(Loss)*tax rate | $ 90,000 | |||||||
| Sale price after-tax | Sale price less tax | $ 210,000 | |||||||
| Calculation of annual operating cash flow | |||||||||
| Year-1 | Year-2 | Year-3 | Year-4 | ||||||
| No of units | 600.00 | 600.00 | 600.00 | 600.00 | |||||
| Selling price | $ 83,000 | $ 84,660 | $ 86,353 | $ 88,080 | Increasing 2% every year | ||||
| Operating ost | $ 61,500 | $ 62,730 | $ 63,985 | $ 65,264 | Increasing 2% every year | ||||
| Sale | $ 49,800,000 | $ 50,796,000 | $ 51,811,920 | $ 52,848,158 | |||||
| Less: Operating Cost | $ 36,900,000 | $ 37,638,000 | $ 38,390,760 | $ 39,158,575 | |||||
| Contribution | $ 12,900,000 | $ 13,158,000 | $ 13,421,160 | $ 13,689,583 | |||||
| Less: Incremental cost | $ 1,600,000 | $ 1,632,000 | $ 1,664,640 | $ 1,697,933 | Increasing 2% every year | ||||
| Less: Depreciation | $ 9,860,000 | $ 9,570,000 | $ 9,570,000 | $ - | |||||
| Profit before tax (PBT) | $ 1,440,000 | $ 1,956,000 | $ 2,186,520 | $ 11,991,650 | |||||
| Tax@30% | PBT*Tax rate | $ 432,000 | $ 586,800 | $ 655,956 | $ 3,597,495 | ||||
| Profit After Tax (PAT) | PBT - Tax | $ 1,008,000 | $ 1,369,200 | $ 1,530,564 | $ 8,394,155 | ||||
| Add Depreciation | PAT + Dep | $ 9,860,000 | $ 9,570,000 | $ 9,570,000 | $ - | ||||
| Cash Profit after-tax | $ 10,868,000 | $ 10,939,200 | $ 11,100,564 | $ 8,394,155 | |||||
| Calculation of working capital movement | |||||||||
| Working capital-opening | $ - | $ 5,500,000 | $ 2,539,800 | $ 2,590,596 | $ 2,642,408 | $ - | |||
| Closing working capital | $ 5,500,000 | $ 2,539,800 | $ 2,590,596 | $ 2,642,408 | $ - | $ - | |||
| Movement | $ 5,500,000 | $ (2,960,200) | $ 50,796 | $ 51,812 | $ (2,642,408) | $ - | |||
| Calculation of NPV | |||||||||
| 10.00% | |||||||||
| Year | Capital | Environment cost | Working capital | Operating cash | Annual Cash flow | PV factor, 1/(1+r)^time | Present values | ||
| 0 | $(29,000,000) |
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