Question

Your company has been doing​ well, reaching $1.19 million in​ earnings, and is considering launching a new product. Designing the new product has already cost $523,000. The company estimates that it will sell 817,000 units per year for $2.98 per unit and variable​ non-labor costs will be $1.15 per unit. Production will end after year 3. New equipment costing $1.03 million will be required. The equipment will be depreciated using​ 100% bonus depreciation under the 2017 TCJA. You think the equipment will be obsolete at the end of year 3 and plan to scrap it. Your current level of working capital is $307,000. The new product will require the working capital to increase to a level of $389,000 ​immediately, then to $392,000 in year​ 1, in year 2 the level will be $344,000​, and finally in year 3 the level will return to $307,000.Your tax rate is 21%. The discount rate for this project is 10.1%. Do the capital budgeting analysis for this project and calculate its NPV. Note​: Assume that the equipment is put into use in year 1. (Round to nearest dollar)

Answer 1

Calculation of NPV of the Project
Particulars	0	1	2	3
Initial Investment
Investment in new equipment (A)	-1030000
Operating Cash Flows
Annual Sales (B = 817,000 * $2.98)		2434660	2434660	2434660
Annual Variable Costs (C = 817,000 * $1.15)		939550	939550	939550
Depreciation (D = $1,030,000 * 100%)	1030000	0	0	0
Profit Before Tax (E = B-C-D)	-1030000	1495110	1495110	1495110
Tax @21% (F = E*21%)	-216300	313973.1	313973.1	313973.1
Profit After Tax (G = E-F)	-813700	1181136.9	1181136.9	1181136.9
Add back Depreciation (H = D)	1030000	0	0	0
Net Operating Cash Flows (I = G+H)	216300	1181136.9	1181136.9	1181136.9
Net Working Capital Requirement
Net Working Capital (J) Y0: ($307,000 - $389,000 = -$82,000) Y1: ($389,000 - $392,000 = -$3,000) Y2: ($392,000 - $344,000 = $48,000) Y3: ($344,000 - $307,000 = $37,000)	-82000	-3000	48000	37000
Total Cash Flows (K = A+I+J)	-895700	1178136.9	1229136.9	1218136.9
Discount Factor @10.1% (L) 1/(1+10.1%)^n n=0,1,2,3	1	0.908265213	0.824945698	0.74926948
Discounted Cash Flows (M = K*L)	-895700	1070060.763	1013971.198	912712.8022
NPV of the Project	2101044.763

Therefore, NPV of the project is $2,101,045