Question

Firm XYZ is considering a project to built a new facility to install a new production line. The firm requires a minimum return of 10% in this project, due to the risks involved. The firm is a 34% tax bracket. Sales, revenues and costs details are given in the table below:

Cost of new plant and equipment	$9,700,000
Shipping and installations costs	$300,000
Unit Sales forecasted                                              Year 1 50,000           Year 2 100,000           Year 3 100,000         Year 4 70,000         Year 5 50,000
Sales price per unit sold	$145
Variable costs per unit produced	$80
Annual fixed costs	$500,000
Net Working Capital requirements	An initial $100,000 will be needed to start production. After that, net working capital requirements until year 5 will be equal to 5% of the total sales for the year. No NWC will be recuperated at the end of year 5
Depreciation	Using the straight-line method, the depreciation expense is $2,000,000 per year during the five years of the project life.

Tasks:

Estimate the CCFA for the next 5 years of operation

Using the NPV and IRR decision methods, decide if the firm should take the project.

Answer 1

Year	Investment	Sales units	Sales in $	VC in $	FC	Depreciation	Net income	Tax @ 34%	Income after tax	Cash inflow	Workin capital		Add/ Release in WC		Net Cashflow
0	-10,000,000												-100,000		-10,100,000
1		50000	7250000	4000000	500,000	2,000,000	750,000	255000	495,000	2,495,000	362500		-262500		2,232,500
2		100000	14500000	8000000	500,000	2,000,000	4,000,000	1360000	2,640,000	4,640,000	725000		-362500		4,277,500
3		100000	14500000	8000000	500,000	2,000,000	4,000,000	1360000	2,640,000	4,640,000	725000		0		4,640,000
4		70000	10150000	5600000	500,000	2,000,000	2,050,000	697000	1,353,000	3,353,000	507500		217500		3,570,500
5		50000	7250000	4000000	500,000	2,000,000	750,000	255000	495,000	2,495,000	362500		145000		2,640,000
Note: Working capital i.e. 5% of Sales has been inrtroodcued or released at the end of each year
NPV
Year		cashflows	PVf @ 10%	Present value
0		-10,100,000	1	-10100000
1		2,232,500	0.909091	2029545
2		4,277,500	0.826446	3535124
3		4,640,000	0.751315	3486101
4		3,570,500	0.683013	2438700
5		2,640,000	0.620921	1639232
		NPV		3028701
Req 2: IRR
Npv at 25%
Year		cashflows	PVf @ 25%	Present value
0		-10,100,000	1	-10100000
1		2,232,500	0.8	1786000
2		4,277,500	0.64	2737600
3		4,640,000	0.512	2375680
4		3,570,500	0.4096	1462477
5		2,640,000	0.32768	865075.2
		NPV		-873168
IRR = Lower rate + (NPV at lower rate / Difference in NPV )* Difference in rates
	10% + (3028,701 / 3901869) * 15% = 21.64%
NPV at 10%		$3,028,701
IRR		21.64%