Question

The Bruin's Den Outdoor Gear is considering a new 7-year project to produce a new tent line. The equipment necessary would cost $2.03 million and be depreciated using straight-line depreciation to a book value of zero. At the end of the project, the equipment can be sold for 15 percent of its initial cost. The company believes that it can sell 31,500 tents per year at a price of $80 and variable costs of $39 per tent. The fixed costs will be $555,000 per year. The project will require an initial investment in net working capital of $257,000 that will be recovered at the end of the project. The required rate of return is 12.3 percent and the tax rate is 40 percent. What is the NPV?

Answer 1

Time line		0	1	2	3	4	5	6	7
Cost of new machine		-2030000
Initial working capital		-257000
=Initial Investment outlay		-2287000
Unit sales			31500	31500	31500	31500	31500	31500	31500
Profits	=no. of units sold * (sales price - variable cost)		1291500	1291500	1291500	1291500	1291500	1291500	1291500
Fixed cost			-555000	-555000	-555000	-555000	-555000	-555000	-555000
-Depreciation	Cost of equipment/no. of years		-290000	-290000	-290000	-290000	-290000	-290000	-290000
=Pretax cash flows			446500	446500	446500	446500	446500	446500	446500
-taxes	=(Pretax cash flows)*(1-tax)		267900	267900	267900	267900	267900	267900	267900
+Depreciation			290000	290000	290000	290000	290000	290000	290000
=after tax operating cash flow			557900	557900	557900	557900	557900	557900	557900
reversal of working capital									257000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)								182700
+Tax shield on salvage book value	=Salvage value * tax rate								0
=Terminal year after tax cash flows									439700
Total Cash flow for the period		-2287000	557900	557900	557900	557900	557900	557900	997600
Discount factor=	(1+discount rate)^corresponding period	1	1.123	1.261129	1.4162479	1.5904464	1.7860713	2.005758	2.252466
Discounted CF=	Cashflow/discount factor	-2287000	496794.301	442381.39	393928.22	350782.03	312361.56	278149.21	442892.3
NPV=	Sum of discounted CF=	430289.02