Question

Creole Restaurant is considering the purchase of a $33,000 souffle maker. The souffle maker has an economic life of six years and will be fully depreciated by the straight-line method. The machine will produce 2,400 souffles per year, with each costing $2 to make and priced at $7. Assume that the discount rate is 14 percent and the tax rate is 34 percent. Should the company make the purchase?

Answer 1

We need to calculate the NPV of the investment:

Particulars	Remark	0	1	2	3	4	5	6
Units Sold	Given		2400.00	2400.00	2400.00	2400.00	2400.00	2400.00
SP	Given		$             7.00	$             7.00	$             7.00	$             7.00	$             7.00	$             7.00
Sales	SP x Units		$   16,800.00	$   16,800.00	$   16,800.00	$   16,800.00	$   16,800.00	$   16,800.00
VC per unit	Given		$             2.00	$             2.00	$             2.00	$             2.00	$             2.00	$             2.00
Total VC	Units x vc per unit		$     4,800.00	$     4,800.00	$     4,800.00	$     4,800.00	$     4,800.00	$     4,800.00
EBITDA	Sales-Total VC		$   12,000.00	$   12,000.00	$   12,000.00	$   12,000.00	$   12,000.00	$   12,000.00
Depreciation	33000/6 = 5500		$     5,500.00	$     5,500.00	$     5,500.00	$     5,500.00	$     5,500.00	$     5,500.00
EBT	EBITDA-Depreciation		$     6,500.00	$     6,500.00	$     6,500.00	$     6,500.00	$     6,500.00	$     6,500.00
Tax	34% x EBT		$     2,210.00	$     2,210.00	$     2,210.00	$     2,210.00	$     2,210.00	$     2,210.00
EAT	EBT-Tax		$     4,290.00	$     4,290.00	$     4,290.00	$     4,290.00	$     4,290.00	$     4,290.00
Depreciation	Added back as non cash		$     5,500.00	$     5,500.00	$     5,500.00	$     5,500.00	$     5,500.00	$     5,500.00
OCF	EAT+Depreciation		$     9,790.00	$     9,790.00	$     9,790.00	$     9,790.00	$     9,790.00	$     9,790.00
FCINV	Given	$ -33,000.00
FCF	OCF+FCINV	$ -33,000.00	$     9,790.00	$     9,790.00	$     9,790.00	$     9,790.00	$     9,790.00	$     9,790.00
Discount factor Formula	at 14 %	1/(1+0.14)^0	1/(1+0.14)^1	1/(1+0.14)^2	1/(1+0.14)^3	1/(1+0.14)^4	1/(1+0.14)^5	1/(1+0.14)^6
Discount factor	Calculated using above formula	1	0.877192982	0.769467528	0.674971516	0.592080277	0.519368664	0.455586548
DCF	FCF x Discount Factor	$ -33,000.00	$     8,587.72	$     7,533.09	$     6,607.97	$     5,796.47	$     5,084.62	$     4,460.19
NPV = sum of all DCF	$                                 5,070.05

As the NPV is positive, the project is profitable and should be taken up.