Question

This project involves a new type of widget. We think we can sell 6,000 units of the widget per year at a price of $950 each. Variable costs will run about $400 per unit and the product should have a four-year life.

Fixed Costs for the project will run $450,000 per year and we will need to invest a total of $1,200,000 in manufacturing equipment. The equipment will be depicted using MACRS over seven years. In year four, the equipment will be worth half of what we paid for it.

We will invest $1,150,000 in net working capital at the start. After that, net working capital requirements will be 25% of sales. Assume a 34% tax rate.

MACRS Table:

Year 1 = 14.29%

Year 2 = 24.49%

Year 3 = 17.49%

Year 4 = 12.49%

Should we undertake the project?

HINT: Prepare a pro forma income statement for each year. Then calculate OCF. Draw this on a timeline then calculate NPV assuming a 28% required return. Show work using Excel.

Answer 1

Tax rate		34%
	Year-0	Year-1	Year-2	Year-3	Year-4
Units		6,000	6,000	6,000	6,000
Sale Price		950	950	950	950
variable cost		400	400	400	400
Sale		5,700,000	5,700,000	5,700,000	5,700,000
Less: Operating Cost		2,400,000	2,400,000	2,400,000	2,400,000
Contribution		3,300,000	3,300,000	3,300,000	3,300,000
Less: Fixed Cost		450,000	450,000	450,000	450,000
Less: Depreciation as per table given below		171,480	293,880	209,880	149,880
Profit before tax		2,678,520	2,556,120	2,640,120	2,700,120
Tax		910,697	869,081	897,641	918,041
Profit After Tax		1,767,823	1,687,039	1,742,479	1,782,079
Add Depreciation		171,480	293,880	209,880	149,880
Cash Profit After tax		1,939,303	1,980,919	1,952,359	1,931,959
Working capital-opening	-	1,150,000	1,425,000	1,425,000	1,425,000
Closing working capital	1,150,000	1,425,000	1,425,000	1,425,000	-
Movement	1,150,000	275,000	-	-	(1,425,000)
Cost of macine			1,200,000
Depreciation			825,120
WDV			374,880
Sale price			600,000
Profit/(Loss)			225,120
Tax			76,541
Sale price after tax			523,459
Depreciation		Year-1	Year-2	Year-3	Year-4		Total
Cost		1,200,000	1,200,000	1,200,000	1,200,000
Dep Rate		14.29%	24.49%	17.49%	12.49%
Deprecaition		171,480	293,880	209,880	149,880		825,120
Calculation of NPV
						28.00%
Year		Captial	Working captial	Operating cash	Annual Cash flow	PV factor	Present values
0		(1,200,000)	(1,150,000)		(2,350,000)	1.000	(2,350,000)
1			(275,000)	1,939,303	1,664,303	0.781	1,300,237
2			-	1,980,919	1,980,919	0.610	1,209,057
3			-	1,952,359	1,952,359	0.477	930,957
4		523,459	1,425,000	1,931,959	3,880,418	0.373	1,445,569
					Net Present Value		2,535,820