United Pigpen is considering a proposal to manufacture high-protein hog feed. The project would require use of an existing warehouse, which is currently rented out to a neighboring firm. The next year’s rental charge on the warehouse is $110,000, 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 $1.26 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 $420,000. Finally, the project requires an immediate investment in working capital of $360,000. Thereafter, working capital is forecasted to be 10% of sales in each of years 1 through 7. Working capital will be run down to zero in year 8 when the project shuts down. Year 1 sales of hog feed are expected to be $4.40 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 25%. The cost of capital is 12%.
What is the NPV of Pigpen’s project? (Do not round intermediate calculations. Enter your answer in dollars not in millions, rounded to the nearest whole dollars.)
NPV=??
Solution
Calculation of the NPV of Pigpen’s project is as under:
Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 |
Sales | 4,400,000.00 | 4,620,000.00 | 4,851,000.00 | 5,093,550.00 | 5,348,227.50 | 5,615,638.88 | 5,896,420.82 | 6,191,241.86 | |
Manufacturing Cost | (3,960,000.00) | (4,158,000.00) | (4,365,900.00) | (4,584,195.00) | (4,813,404.75) | (5,054,074.99) | (5,306,778.74) | (5,572,117.67) | |
Warehour Rental Income | (110,000.00) | (114,400.00) | (118,976.00) | (123,735.04) | (128,684.44) | (133,831.82) | (139,185.09) | (144,752.50) | |
Depreciation | (126,000.00) | (126,000.00) | (126,000.00) | (126,000.00) | (126,000.00) | (126,000.00) | (126,000.00) | (126,000.00) | |
Profit Before Tax | 204,000.00 | 221,600.00 | 240,124.00 | 259,619.96 | 280,138.31 | 301,732.07 | 324,456.99 | 348,371.69 | |
Tax | (51,000.00) | (55,400.00) | (60,031.00) | (64,904.99) | (70,034.58) | (75,433.02) | (81,114.25) | (87,092.92) | |
Profit After Tax | 153,000.00 | 166,200.00 | 180,093.00 | 194,714.97 | 210,103.73 | 226,299.05 | 243,342.74 | 261,278.77 | |
Depreciation | 126,000.00 | 126,000.00 | 126,000.00 | 126,000.00 | 126,000.00 | 126,000.00 | 126,000.00 | 126,000.00 | |
Cash flow after tax | 279,000.00 | 292,200.00 | 306,093.00 | 320,714.97 | 336,103.73 | 352,299.05 | 369,342.74 | 387,278.77 | |
Initial Invetment | (1,260,000.00) | ||||||||
Working Capital (Note 1) | (360,000.00) | (5,000.00) | (22,000.00) | (23,100.00) | (24,255.00) | (25,467.75) | (26,741.14) | (28,078.19) | |
Release of Working Capital | 589,642.08 | ||||||||
Resell Value | 420,000.00 | ||||||||
Total Cash Flows | (1,620,000.00) | 274,000.00 | 270,200.00 | 282,993.00 | 296,459.97 | 310,635.98 | 325,557.91 | 341,264.55 | 1,396,920.85 |
Cost of Capital | 12% | ||||||||
NPV` | =NPV(rate, value1,value2,value3..) | ||||||||
NPV | $258,610.50 |
Hence, the NPV of Pigpen’s project is $ 258610.50
Note 1: Calculation of Working Capital Requirement
Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 |
Sales | 4,400,000.00 | 4,620,000.00 | 4,851,000.00 | 5,093,550.00 | 5,348,227.50 | 5,615,638.88 | 5,896,420.82 | 6,191,241.86 | |
Working Capital to be 10% of sales | 435,000.00 | 440,000.00 | 462,000.00 | 485,100.00 | 509,355.00 | 534,822.75 | 561,563.89 | 589,642.08 | 0 |
Additional Working Capital requirement | 5,000.00 | 22,000.00 | 23,100.00 | 24,255.00 | 25,467.75 | 26,741.14 | 28,078.19 | (589,642.08) |
United Pigpen is considering a proposal to manufacture high-protein hog feed. The project would require use...
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