Question

Chapter 15 Capital Budgeting 45. LO.2 & LO.3 (Time line; payback; NPV) Holly's Fashions is considering expandi its building so it can stock additional merchandise for travelers and tourists. Store man ager Jill Eliason anticipates that building expansion costs would be $190,000. Th firm's suppliers are willing to provide inventory on a consignment basis so there would be no additional working capital needed upon expansion. Annual incremental fixed cash costs for the store expansion are expected to be as follows: Year Amount 1 $20,000 27,000 27,000 27,000 30,000 30,000 30,000 33,000 2 4 5 7 8 Eliason estimates that annual cash inflows could be increased by $60,000 of contribu tion margin generated from the additional merchandise sales. Because of uncertainty about the future, Eliason does not want to consider any cash flows after eight years The firm uses an 8 percent discount rate a. Construct a time line for the investment b. Determine the payback period. (Ignore taxes.) Calculate the net present value of the project. (Ignore taxes.)

Answer 1

fr X A22 F E D C B A 2 3 STATEMENT SHOWING TIME LINE FOR THE INVESTMENT AND NPV OF THE PROJECT (AMOUNT IN $) 4 PRESENT VALUE INCREMENTAL INCREMENTAL OF CASH FLOWS NET CASH FLOW PVF @ 8% (D) ANNUAL CASH (E)-(C D) [rounded off] (190,000) ANNUAL FIXED YEAR (c)-(B-A) INFLOW (B) CASH COSTS (A) 1.0000 (190,000) 190,000 20,000 27,000 0 37,037 0.9259 40,000 60,000 1 28,292 0.8573 33,000 33,000 60,000 2 8 26,196 0.7938 60,000 27,000 24,256 0.7350 33,000 60,000 27,000 4 10 20,417 18,905 17,505 14,587 0.6806 30,000 60,000 30,000 11 0.6302 30,000 60,000 30,000 6 12 0.5835 30,000 60,000 30,000 7 13 0.5403 27,000 60,000 33,000 -2804 NPV 15 = INITIAL INVESTMENT /NET ANNUAL CASH INFLOW PER YEAR AS WE KNOW, PAYBACK PERIOD = 190000/60000 18 =3.16 19 = 3 YEARS (ROUNDED OFF) 20 21 CONCLUSION: ON THE BASIS OF NPV CALCULATION, PROJECT SHOULD NOT BE ACCEPTED DUE TO ITS NEGATIVE NPV. Sheet1 READY