Question

Drilling-Easy (DE) Inc. currently has two​ products, low-priced drills and a line of smart drill bits. DE Inc. has decided to sell a new line of​ high-priced drills. Sales for the new line of drills are estimated at ​$27million a year. Annual variable costs are 60​% of sales. The project is expected to last 10 years. In addition to the production variable​ costs, the fixed costs each year will be​ $4,000,000. The company has spent ​$1,000,000 in a marketing and research study that determined the company will gain ​$11 million in sales a year of its existing line of smart drill bits. The production variable cost of these sales is ​$9 million a year. The plant and equipment required for producing the​ high-priced drills costs ​$11,000,000 and will be depreciated down to zero over 10 years using​ straight-line depreciation. It is expected that the plant and equipment can be sold for ​$4,000,000 at the end of the project. The project will also require an increase in net working capital of ​$3,000,000 today that will be returned at the end of the project. The tax rate is 20 percent and the require rate of return for this project is 10​%.

A. What is the Initial Outlay (IO) for this project?

B. What is the operating cash flows (OCF) for each of the yeas of the project?

C. What is the termination value (TV) cash flow (aka recovery cost or after tax salvage value, or liquidation value of the assets) at the end of the project?

D. What is the NPV of this project?

Please show all steps because I am very new to finance.

Answer 1

A)	Plant and equipment	$   1,10,00,000
	Increase in NWC	$       30,00,000
	Initial outlay for the project	$   1,40,00,000
B)	Sales	$   2,70,00,000
	Variable cost 60%	$   1,62,00,000
	Fixed costs	$       40,00,000
	Depreciation (11000000/10)	$       11,00,000
	NOI from new line of high priced drills	$       57,00,000
	Add: Addl contribution margin from existing smart line drills = 11 million - 9 million =	$       20,00,000
	Incremental NOI	$       77,00,000
	Tax at 20%	$       15,40,000
	Incremental NOPAT	$       61,60,000
	Add: Depreciation	$       11,00,000
	Operating cash flows for t1 to t10	$       72,60,000
C)	After tax salvage value of plant and equipment = 4000000*(1-20%) =	$       32,00,000
	Recovery of NWC	$       30,00,000
	Terminal value cash flows	$       62,00,000
D)	PV of annual operating cash flows = 7260000*(1.1^10-1)/(0.1*1.1^10) =	$   4,46,09,557
	PV of terminal cash flows = 6200000/1.1^10 =	$       23,90,368
	Total PV of cash inflows	$   4,69,99,926
	Less: Initial investment	$   1,40,00,000
	NPV	$   3,29,99,926