Question

NPV.  Grady Precision Measurement Tools has forecasted the following sales and costs for a new GPS​ system: annual sales of 44,000 units at ​$16 a​ unit, production costs at 39​% of sales​ price, annual fixed costs for production at $ 190,000. The company tax rate is 35​%. What is the annual operating cash flow of the new GPS​ system? Should Grady Precision Measurement Tools add the GPS system to its set of​ products? The initial investment is ​$1,400,000 for manufacturing​ equipment, which will be depreciated over six years​ (straight line) and will be sold at the end of five years for $ 380,000. The cost of capital is 10​%.

a. What is the annual operating cash flow of the new GPS​ system?

b. What is the​ after-tax cash flow of the GPS system at​ disposal?

c. What is the NPV of the new GPS​ system?

d. Should Grady Precision Measurement Tools add the GPS system to its set of​ products?

Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-1400000
=Initial Investment outlay		-1400000
								100.00%
Unit sales			44000	44000	44000	44000	44000
Profits	=no. of units sold * (sales price - variable cost)		429440	429440	429440	429440	429440
Fixed cost			-190000	-190000	-190000	-190000	-190000
-Depreciation	Cost of equipment/no. of years		-233333.333	-233333.33	-233333.33	-233333.33	-233333.3	233333.33	=Salvage Value
=Pretax cash flows			6106.666667	6106.66667	6106.66667	6106.66667	6106.6667
-taxes	=(Pretax cash flows)*(1-tax)		3969.333333	3969.33333	3969.33333	3969.33333	3969.3333
+Depreciation			233333.3333	233333.333	233333.333	233333.333	233333.33
=a. after tax operating cash flow			237302.6667	237302.667	237302.667	237302.667	237302.67
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						247000
+Tax shield on salvage book value	=Salvage value * tax rate						81666.667
=b. Terminal year after tax cash flows							328666.67
Total Cash flow for the period		-1400000	237302.6667	237302.667	237302.667	237302.667	565969.33
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331	1.4641	1.61051
Discounted CF=	Cashflow/discount factor	-1400000	215729.697	196117.906	178289.006	162080.914	351422.43
c. NPV=	Sum of discounted CF=	-296360.0493

d.

Reject as NPV is negative