Question

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 9,000 in the first year, with growth of 7 percent each year for the following four years (Years 2 through 5). Production of these lamps will require $55,000 in networking capital to start. Total fixed costs are $115,000 per year, variable production costs are $24 per unit, and the units are priced at $52 each. The equipment needed to begin production will cost $195,000. 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 40 percent, and the required rate of return is 25 percent. What is the NPV of this project?

Answer 1

Solution:
Calculation of Quantity sold each year for 5 years:
Year	Quantity Sold	Working
1	9000
2	9630	(9000*1.07)
3	10304	(9630*1.07)
4	11025	(10304*1.07)
5	11797	(11025*1.07)
Each Year Quantity would increase by 7% from prevous year.
Given:
Net working Capital Required		$55000 at Start
Total Fixed Costs		$115000 per year
Variable costs		$24 Per unit
Selling Price per unit		$52 Per unit
Equipment		$195000
Depreciation method		SLM Method with no Salvage
Therefor Depreciation Amount		$195000/5 =$39000
Tax rate		40%
Required rate of return		25%
Profoma Income statement for each Year:
		Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Revenue			468000	500760	535808	573300	613444
(No of Units Sold * S.P.Per unit)			(9000*52)	(9630*52)	(10304*52)	(11025*52)	(11797*52)
Less: Fixed Costs (Given)			-115000	-115000	-115000	-115000	-115000
Less: Variable Costs			-216000	-231120	-247296	-264600	-283128
			(9000*24)	(9630*24)	(10304*24)	(11025*24)	(11797*24)
Less:Depreciation			-39000	-39000	-39000	-39000	-39000
Net Profit Before Tax			98000	115640	134512	154700	176316
Less: Income Tax @ 40%			-39200	-46256	-53804.8	-61880	-70526.4
(Net Profit before tax * Tax rate)
Net Profit After Tax			58800	69384	80707.2	92820	105789.6
Add:Depreciation			39000	39000	39000	39000	39000
Operating Cash Flow			97800	108384	119707.2	131820	144789.6
Add: Recovery of Working Capital			0	0	0	0	55000
Total Cash Flow			97800	108384	119707.2	131820	199789.6
Cash Outflow:
Equipment Purchase		-195000
Net working Capital		-55000
Cash Outflow		-250000
NPV = PV of Inflow- PV of Outflow
$328356.38-$250000
78356.38
PV of Inflow
Year		Cash Flow	Discounting Factor @ 25%	Working	Discounted Cash Flow
		a	b		c = a*b
1	$	97800	0.8	(1/1.25^1)	78240
2	$	108384	0.64	(1/1.25^2)	69365.76
3	$	119707.2	0.512	(1/1.25^3)	61290.0864
4	$	131820	0.4096	(1/1.25^4)	53993.472
5	$	199789.6	0.32768	(1/1.25^5)	65467.0561
	$				328356.375
NPV of this project = $78356.38