Question

United Pigpen is considering a proposal to manufacture high-protein hog feed. The project would make use of an existing warehouse, which is currently rented out to a neighboring firm. The next year's rental charge for the warehouse is $100,000, and thereafter the rent is expected to grow in line with inflation at 4 percent per year. In addition to use of the warehouse, the proposal envisages an investment in plant and equipment of $1.2 million. This could be depreciated straight-line for tax purposes over 10 years. However, Pigpen expects to terminate the project at the end of eight years and to resell the plant and equipment in Year 8 for $400,000. Finally, the project requires an initial investment in working capital of $350,000. Thereafter, working capital is forecasted to be 10 percent of sales in each of Years 1–7.

Year 1 sales of hog feed are expected to be $4.2 million, and thereafter sales are forecast to grow by 5 percent per year—slightly faster than the inflation rate. Manufacturing costs are expected to be 90 percent of sales, and projects are subject to tax at 35 percent. The cost of capital is 12 percent. What is the NPV of Pigpen's project?

Answer 1