Question

1. Dickinson Brothers, Inc., is considering investing in a machine to produce computer keyboards. The price of the machine will be $975,000, and its economic life is five years. The machine will be fully depreciated by the straight-line method. The machine will produce 20,000 keyboards each year. The price of each keyboard will be $40 in the first year and will increase by 5 percent per year. The production cost per keyboard will be $15 in the first year and will increase by 6 percent per year. The project will have an annual fixed cost of $195,000 and require an immediate investment of $25,000 in net working capital. The corporate tax rate for the company is 34 percent. If the appropriate discount rate is 11 percent, what is the NPV of the investment?

Answer 1

Calculation of NPV of investment
Year	0	1	2	3	4	5	NPV
Investment in Machine	-$975,000
Increase in net working capital	-$25,000
Operating cash flow		$267,600	$282,120	$297,247	$313,005	$329,417
Net Cash flow	-$1,000,000	$267,600	$282,120	$297,247	$313,005	$329,417
X Discount factor @ 11%	1.00000	0.90090	0.81162	0.73119	0.65873	0.59345
Present Value	-$1,000,000	$241,081	$228,975	$217,345	$206,186	$195,493	$89,079
NPV of investment	$89,079
Working 1
Calculation of operating cash flow for the project over 5 years
Year	1	2	3	4	5
Production Units	20000	20000	20000	20000	20000
x Sales price per car	$40.00	$42.00	$44.10	$46.31	$48.62
Sales	$800,000.00	$840,000.00	$882,000.00	$926,100.00	$972,405.00
Production cost per unit	$15.00	$15.90	$16.85	$17.87	$18.94
Less : Production cost (units x per unit cost)	$300,000.00	$318,000.00	$337,080.00	$357,304.80	$378,743.09
Contribution Margin	$500,000.00	$522,000.00	$544,920.00	$568,795.20	$593,661.91
Less : Fixed cost	$195,000.00	$195,000.00	$195,000.00	$195,000.00	$195,000.00
Less : Depreciation	$195,000.00	$195,000.00	$195,000.00	$195,000.00	$195,000.00
Profit before tax	$110,000.00	$132,000.00	$154,920.00	$178,795.20	$203,661.91
Less : Tax @ 34%	$37,400.00	$44,880.00	$52,672.80	$60,790.37	$69,245.05
Add : Depreciation	$195,000.00	$195,000.00	$195,000.00	$195,000.00	$195,000.00
Operating Cash flow	$267,600	$282,120	$297,247	$313,005	$329,417
Working-2
Depreciation per year using straight line method = (Cost of machine - salvage value)/useful life
Depreciation per year using straight line method = ($9,75,000 - $0)/5 years
Depreciation per year using straight line method = $1,95,000