Question

RougeRiver Furniture Limited projects unit sales for a new line of office desk to be as follows:

Year 1 2 3 4 5

Sales 2,000 4,000 5,000 3,000 1,000
Production of office desks will require net working capital each year equal to 20% of the sales revenues of the following year. Any remaining net working capital will be fully recovered at the end of year 5. Total fixed costs are $100,000 per year, variable costs are $80 per unit, and the desks are priced at $400 each. The plant and equipment needed for production will cost $1,000,000, and will have CCA rate of 25% on declining balance, and at the end of 5 years can be sold for $100,000. Assume asset pool is closed (any gain or loss on the disposal of the plant and equipment will be taxable/tax deductible). The company has a marginal tax rate of 40% and requires a return of 15% on the projects of this type. Should the company go ahead with the new line of office desk project?

Answer 1

Tax rate		40%
	Year-0	Year-1	Year-2	Year-3	Year-4	Year-5
Tons		2,000	4,000	5,000	3,000	1,000
Sale Price		400	400	400	400	400
variable cost		80	80	80	80	80
Sale		800,000	1,600,000	2,000,000	1,200,000	400,000
Less: Operating Cost		160,000	320,000	400,000	240,000	80,000
Contribution		640,000	1,280,000	1,600,000	960,000	320,000
Less: Fixed Cost		100,000	100,000	100,000	100,000	100,000
Less: Depreciation as per table given below		250,000	187,500	140,625	105,469	79,102
Profit before tax		290,000	992,500	1,359,375	754,531	140,898
Tax		116,000	397,000	543,750	301,813	56,359
Profit After Tax		174,000	595,500	815,625	452,719	84,539
Add Depreciation		250,000	187,500	140,625	105,469	79,102
Cash Profit After tax		424,000	783,000	956,250	558,188	163,641
Working capital-opening	-	160,000	320,000	400,000	240,000	80,000
Closing working capital	160,000	320,000	400,000	240,000	80,000	-
Movement	160,000	160,000	80,000	(160,000)	(160,000)	(80,000)
Cost of macine			1,000,000
Depreciation			762,695
WDV			237,305
Sale price			100,000
Profit/(Loss)			(137,305)
Tax			(54,922)
Sale price after tax			154,922
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Total
Cost		1,000,000	750,000	562,500	421,875	316,406
Dep Rate		25.00%	25.00%	25.00%	25.00%	25.00%
Deprecaition		250,000	187,500	140,625	105,469	79,102	762,695
WDV		750,000	562,500	421,875	316,406	237,305
Calculation of NPV
						15.00%
Year		Captial	Working captial	Operating cash	Annual Cash flow	PV factor	Present values
0		(1,000,000)	(160,000)		(1,160,000)	1.000	(1,160,000)
1			(160,000)	424,000	264,000	0.870	229,565
2			(80,000)	783,000	703,000	0.756	531,569
3			160,000	956,250	1,116,250	0.658	733,952
4			160,000	558,188	718,188	0.572	410,626
5		154,922	80,000	163,641	398,563	0.497	198,156
					Net Present Value		943,869
Since NPV is positive, the project should be undertaken.