With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden...

With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital, they decided to focus on surf print table and floor lamps to accent people’s homes. They projected unit sales of these lamps to be 7,000 in the first year, with growth of 8 percent each year for the next five years. Production of these lamps will require GH¢35,000 in net working capital to start. Total fixed costs are GH¢ 95,000 per year, variable production costs are GH¢ 20 per unit, and the units are priced at GH¢48 each. The equipment needed to begin production will cost GH¢175,000. The equipment will be depreciated using the straight-line method over a five-year life and is not expected to have a salvage value. The effective tax rate is 34 percent, and the required rate of return is 25 percent. Evaluate the project using NPV.

Expert Solution

The first step would be to compute units sold at growth rate of 8% after the year 2 to Year 5.

Depreciation is computed using straight line method.

Depreciation = 175000/5 = 35000

Operating cash flows is sum of net income and depreciation

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Quantity sold with growth at 8%	0	7000	7560	8164.8	8817.984	9523.423
Revenue per unit		48	48	48	48	48

Revenue		336000	362880	391910.4	423263.2	457124.3
Fixed costs		95000	95000	95000	95000	95000
variable costs at 20		140000	151200	163296	176359.7	190468.5
Depreciation (175000/5)		35000	35000	35000	35000	35000

Earnings before tax		66000	81680	98614.4	116903.6	136655.8
Taxes at 34%		22440	27771.2	33528.9	39747.21	46462.98
Net income		43560	53908.8	65085.5	77156.34	90192.85
Operating cash flow = net income + deprn		78560	88908.8	100085.5	112156.3	125192.9

Initial capital spent	-175,000
Net working capital	-35000					35000
Total cash flows	-210000	78560	88908.8	100085.5	112156.3	160192.9

Present value factor at 25%	1.00000	0.80000	0.64000	0.51200	0.40960	0.32768

Present value	-210000	62848	56901.63	51243.78	45939.24	52491.99

Present value of cash inflows = 62848 + 56901.63 + 51243.78 + 45939.24 +52491.99 = 269424.6

Cash outflows = 210,000

Net present value = 269424.6 – 210,000 = 59424.6

The project has positive NPV and should be taken

ekkarill92 answered 1 year ago

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With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden...

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