Question

United Pigpen is considering a proposal to manufacture high-protein hog feed. The project would make use of an existing warehouse, which is currently rented out to a neighboring firm. The next year’s rental charge on the warehouse is $100,000, and thereafter, the rent is expected to grow in line with inflation at 4% a year. In addition to using the warehouse, the proposal envisages an investment in plant and equipment of $1.2 million. This could be depreciated for tax purposes straight-line over 10 years. However, Pigpen expects to terminate the project at the end of 8 years and to resell the plant and equipment in year 8 for $400,000. Finally, the project requires an immediate investment in working capital of $350,000. Thereafter, working capital is forecasted to be 10% of sales in each of years 1 through 7. Year 1 sales of hog feed are expected to be $4.2 million, and thereafter, sales are forecasted to grow by 5% a year, slightly faster than the inflation rate. Manufacturing costs are expected to be 90% of sales, and profits are subject to tax at 35%. The cost of capital is 12%. What is the NPV of Pigpen’s project? (Enter your answer in dollars not in millions.)

Answer 1

	0	1	2	3	4	5	6	7	8
Sales		$     42,00,000	$     44,10,000	$       46,30,500	$      48,62,025	$       51,05,126	$ 53,60,383	$ 56,28,402	$ 59,09,822
Manufacturing costs [90% of sales]		$     37,80,000	$     39,69,000	$       41,67,450	$      43,75,823	$       45,94,614	$ 48,24,344	$ 50,65,562	$ 53,18,840
Depreciation [1200000/10]		$       1,20,000	$       1,20,000	$          1,20,000	$        1,20,000	$          1,20,000	$     1,20,000	$     1,20,000	$    1,20,000
Loss of rent from warehouse		$       1,00,000	$       1,04,000	$          1,08,160	$        1,12,486	$          1,16,986	$     1,21,665	$     1,26,532	$    1,31,593
Incremental NOI		$       2,00,000	$       2,17,000	$          2,34,890	$        2,53,716	$          2,73,527	$     2,94,373	$     3,16,308	$    3,39,389
Tax at 35%		$           70,000	$           75,950	$             82,212	$            88,801	$             95,734	$     1,03,031	$     1,10,708	$    1,18,786
Incremental NOPAT		$       1,30,000	$       1,41,050	$          1,52,679	$        1,64,915	$          1,77,792	$     1,91,342	$     2,05,600	$    2,20,603
Add: Depreciation		$       1,20,000	$       1,20,000	$          1,20,000	$        1,20,000	$          1,20,000	$     1,20,000	$     1,20,000	$    1,20,000
Incremental OCF		$       2,50,000	$       2,61,050	$          2,72,679	$        2,84,915	$          2,97,792	$     3,11,342	$     3,25,600	$    3,40,603
Capital expenditure	$   12,00,000
Change in NWC	$      3,50,000	$           70,000	$           21,000	$             22,050	$            23,153	$             24,310	$        25,526	$        26,802	$   -5,62,840
After tax salvage value = 400000-(400000-240000)*35% =									$    3,44,000
Annual after tax cash flows	$ -15,50,000	$       1,80,000	$       2,40,050	$          2,50,629	$        2,61,763	$          2,73,482	$     2,85,817	$     2,98,798	$ 12,47,443
PVIF at 12% [PVIF = 1/1.12^n]	1	0.89286	0.79719	0.71178	0.63552	0.56743	0.50663	0.45235	0.40388
PV at 12%	$ -15,50,000	$       1,60,714	$       1,91,366	$          1,78,392	$        1,66,355	$          1,55,181	$     1,44,804	$     1,35,161	$    5,03,821
NPV	$         85,796