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Werton Corporation has developed a new processor that would be used by many specialty companies. It...

  1. 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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