Question

Renegade Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2.86 million and will last for six years. Variable costs are 34% of sales, and fixed costs are $1,971,998 per year. Machine B costs $5.06 million and will last for nine years. Variable costs for this machine are 24% of sales and fixed costs are $1,287,522 per year. The sales for each machine will be $6.1 million per year. The required return is 7 %, and the tax rate is 38%. Both machines will be depreciated to zero on a straight-line basis. Each project will require an increase in inventory of $372,030, an increase in accounts receivable of $719,471, and an increase in accounts payable of $353,015. Assume a salvage value of $786,221 for both machines.

Calculate the NPV for machine A. (Round answer to 2 decimal places. Do not round intermediate calculations)

Answer 1

NPV of the machine A is $4,262,631

Explanations: -

Step 1. Calculation of Initial investment   

Initial investment   is $3,598,486

Initial investment = cost of machine + increase in Net working

1. cost of machine = $2,860,000

2. increase in Net working capital = increase in inventory + increase in accounts receivable – increase in accounts payable

= $372,030 + $719,471 - $353,015

=738486

cash flow (year 0) = (2860000 + 738,486) = $3,598,486

Step 2. Calculation of Yearly Operating Cash Flow

Yearly operating Cash Flow is $1454614.7

Yearly operating Cash Flow
Annual sales	6,100,000
Variable costs (34% of sales)	2,074,000
Fixed costs	$1,971,998
Depreciation (2,860,000/ 6)	(476667)
Earnings before tax	1577335
Taxes (38%)	(599387.3)
Earnings after tax	977947.7
Add Non-cash expenses(depreciation)	476667
Yearly operating Cash Flow	1454614.7

Step 3. Calculation of Terminal cash flow of the project

Terminal cash flow of the project is $1,225,943

Terminal cash flow = NSV of project assets + Recovered Net working capital

NSV of project assets

=Salvage value * (1-tax rate)

= $786,221 * (1-.38)

= $786,221 * .62

= $487,457

Recovered Net working capital = $738486

Therefore, Terminal cash flow =$487,457+ $738486 = $1,225,943

Step 4. Calculation of NPV

NPV of the project is $4,262,631

CALCULATIONS: -

Years	0	1	2	3	4	5	6
cost of equipment	-$2,860,000
change in net working capital	-$738,486			$738,486
operating cash flow		$1,454,615	$1,454,615	$1,454,615	$1,454,615	$1,454,615	$1,454,615
NSV of new equipment							$487,457
Total cash flows	-$3,598,486	$1,454,615	$1,454,615	$2,193,101	$1,454,615	$1,454,615	$1,942,072
PVIF @   7%	1	0.935	0.873	0.816	0.763	0.713	0.666
Discounted cash flows	-$3,598,486	$1,359,453	$1,270,517	$1,790,224	$1,109,719	$1,037,120	$1,294,084
Sum of Discounted cash flows from year 1 to 6 = $7,861,117

NPV = PV of future expected net cash inflows – initial investment

Initial investment = $3,598,486

NPV=   $7,861,117 - $3,598,486

NPV = $4,262,631