Question

Please help explain the answer to these questions, along with the equations used to calculate them.

United Technologies Project Analysis United Technologies is considering building a new manufacturing plant to produce super energy efficient "Home Climate Control Systems” through its Carrier division. The project would require an initial investment in new production facilities and equipment of $400 million in 2020 would fall in the 5-year MACRS depreciation class. United Technologies has already spent $20 million designing and developing these new systems and they will need additional net working capital of $50 million in 2020. The table following this paragraph contains sales, sale price, variable cost & fixed cost projections over the expected life of the project. The company's marginal tax rate is 40% and this project has a WACC of 9.5%. At the end of 2019, United Technologies will end the project and can sell their production facility & equipment for $85 million in addition to liquidating the extra net working capital that was needed for the project. Year 2020 2021 2022 2023 2024 Unit Sales 100,000 120,000 130,000 135,000 130,000 Sales Price / Unit 3000 3000 3100 3100 3100 Variable Cost/ unit 1800 1800 1900 1950 1950 Fixed Costs 210,000 215,000 220,000 225,000 230,000 Answer the following. 1. What is the initial cash flow for the project? 2. What are the annual operating cash flows for the project? 3. What is the project's terminal cash flow? 4. Calculate the NPV, and IRR for the project. 5. Should UTC accept this project? Explain why.

Answer 1

1. Initial Cash Flow = Cost of equipment + Working capital required

= $ 400 million + $ 50 million = $ 450 million

Note: Amount spent on designing and developing new systems is to be ignored

2. Annual operating cash flows

Year	2020	2021	2022	2023	2024
a. Unit sales	100000	120000	130000	135000	130000
b. Sales Price	3000	3000	3100	3100	3100
c. Variable Cost	1800	1800	1900	1950	1950
d. Contribution per unit (b - c)	1200	1200	1200	1150	1150
e. Contribution (a * d)	120000000	144000000	156000000	155250000	149500000
f. Fixed cost	210000	215000	220000	225000	230000
g. Depreciation Rate	20	32	19.2	11.52	11.52
h. Depreciation ([400 million * g]/100)	80000000	128000000	76800000	46080000	46080000
i. Outflow (e- f - h)	39790000	15785000	78980000	108945000	103190000
j. Tax @ 40% (i * 40%)	15916000	6314000	31592000	43578000	41276000
k. Net Outflow (i - j)	23874000	9471000	47388000	65367000	61914000
Operating cash flow (k + h)	103874000	137471000	124188000	111447000	107994000

3. Terminal Cash Flow = Salvage Value of equipment + Release of working capital

= $ 85 million + $ 50 million = $ 135 million

4. Calculation of NPV

Year	2020	2021	2022	2023	2024
Operating cash flow (k + h)	103874000	137471000	124188000	111447000	107994000
PV @ 9.5%	0.913	0.834	0.762	0.696	0.635
Present Value	94862100	114652322	94588268	77519668	68600776
Total Present Value					450223135
PV of terminal cash flow = 135 million * 0.635					85725000
					535948135
Less: Initial outflow					450000000
NPV					85948135

Calculation of IRR

At IRR, NPV = 0

0 = -450000000 + 103874000 / (1 + IRR) + 137471000 / (1 + IRR)^2 + 124188000 / (1 + IRR)^3 + 111447000 / (1 + IRR)^4 + 107994000 / (1 + IRR)^5

IRR = 9.48%

5. The project should be accepted as NPV is greater than zero.