Question

RET Inc. currently has one product, low-priced stoves. RET Inc. has decided to sell a new line of medium-priced stoves. Sales revenues for the new line of stoves are estimated at $30 million a year. Variable costs are 75% of sales. The project is expected to last 10 years. Also, non-variable costs are $4,000,000 per year. The company has spent $1,000,000 in research and a marketing study that determined the company will lose (cannibalization) $10 million in sales a year of its existing low-priced stoves. The production variable cost of the existing low-priced stoves is $8 million a year.

The plant and equipment required for producing the new line of stoves costs $10,000,000 and will be depreciated down to zero over 20 years using straight-line depreciation. It is expected that the plant and equipment can be sold (salvage value) for $6,000,000 at the end of 10 years. The new stoves will also require today an increase in net working capital of $2,000,000 that will be returned at the end of the project.

The tax rate is 40 percent and the cost of capital is 10%.

5. What is the remaining book value for the plant at equipment at the end of the project?

6. What is the cash flow due to tax on salvage value for this project? Enter a negative # if it is a tax gain (remember in millions and 2 decimals). For example, if your answer is a tax on capital gains of $3,004.80 then enter   -0.03 ; if your answer is a tax shelter from a capital loss of $100,000.20 then enter 0.10  

7. What is the project's cash flow for year 10 for this project?

8. What is the Net Present Value (NPV) for this project?

Answer 1

Tax rate		40%
Calculation of annual depreciation
Depreciation		Year-1-10
Cost		$          10,000,000
Dep Rate (1/20=5%)	10000000*5%*10	10000000*5%*10
Depreciation	Cost * Dep rate	$            5,000,000
Calculation of after-tax salvage value
Cost of machine			$ 10,000,000
Depreciation			$   5,000,000
WDV	Cost less accumulated depreciation	$   5,000,000
Sale price			$   6,000,000
Profit/(Loss)	Sale price less WDV	$   1,000,000
Tax	Profit/(Loss)*tax rate	$      400,000
Sale price after-tax	Sale price less tax		$   5,600,000
Calculation of annual operating cash flow
		Year-1-10
Sale		$          30,000,000
Less: Variable cost-75%		$          22,500,000
Contribution		$            7,500,000
Less: contribution lost	(10-8) million	$            2,000,000
Less: Non-variable cost		$            4,000,000
Less: Depreciation	10000000*5%	$               500,000
Profit before tax (PBT)		$            1,000,000
Tax@40%	PBT*Tax rate	$               400,000
Profit After Tax (PAT)	PBT - Tax	$               600,000
Add Depreciation	PAT + Dep	$               500,000
Cash Profit after-tax		$            1,100,000
Calculation of NPV
						10.00%
Year		Capital	Working capital	Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0		$         (10,000,000)	$ (2,000,000)		$(12,000,000)	1.0000	$(12,000,000)
1				$    1,100,000	$    1,100,000	0.9091	$    1,000,000
2				$    1,100,000	$    1,100,000	0.8264	$       909,091
3				$    1,100,000	$    1,100,000	0.7513	$       826,446
4				$    1,100,000	$    1,100,000	0.6830	$       751,315
5				$    1,100,000	$    1,100,000	0.6209	$       683,013
6				$    1,100,000	$    1,100,000	0.5645	$       620,921
7				$    1,100,000	$    1,100,000	0.5132	$       564,474
8				$    1,100,000	$    1,100,000	0.4665	$       513,158
9				$    1,100,000	$    1,100,000	0.4241	$       466,507
10		$            5,600,000	$   2,000,000	$    1,100,000	$    8,700,000	0.3855	$    3,354,227
					Net Present Value	$ (2,310,847)