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 11,400 in the first year, with growth of 7 percent each year for the next five years. Production of these lamps will require $73,000 in net working capital to start. Total fixed costs are $167,000 per year, variable production costs are $20 per unit, and the units are priced at $65 each. The equipment needed to begin production will cost $645,000. The equipment will be depreciated using the straight-line method over a 5-year life and is not expected to have a salvage value. The tax rate is 24 percent and the required rate of return is 17 percent. What is the NPV of this project?

Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-645000
Initial working capital		-73000
=Initial Investment outlay		-718000
								100.00%
Unit sales			11400	12198	13051.86	13965.49	14943.075
Profits	=no. of units sold * (sales price - variable cost)		513000	548910	587333.7	628447.06	672438.35
Fixed cost			-167000	-167000	-167000	-167000	-167000
-Depreciation	Cost of equipment/no. of years		-129000	-129000	-129000	-129000	-129000	0	=Salvage Value
=Pretax cash flows			217000	252910	291333.7	332447.06	376438.35
-taxes	=(Pretax cash flows)*(1-tax)		164920	192211.6	221413.612	252659.76	286093.15
+Depreciation			129000	129000	129000	129000	129000
=after tax operating cash flow			293920	321211.6	350413.61	381659.76	415093.15
reversal of working capital							73000
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							73000
Total Cash flow for the period		-718000	293920	321211.6	350413.61	381659.76	488093.15
Discount factor=	(1+discount rate)^corresponding period	1	1.17	1.3689	1.601613	1.8738872	2.192448
Discounted CF=	Cashflow/discount factor	-718000	251213.6752	234649.4265	218787.9407	203672.75	222624.73
NPV=	Sum of discounted CF=	412948.52