Mustang Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $280,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $115,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 2 percent. Production costs at the end of the first year will be $40,000, in nominal terms, and they are expected to increase at 3 percent per year. The real discount rate is 5 percent. The corporate tax rate is 40 percent. Calculate the NPV of the project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Computation of annual cash flow:
Depreciation = Initial cost/Useful life = $ 280,000/7 = $ 40,000
Operating Revenue increases 2% p.a. and Production cost increasing 3% p.a.
Year |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
Operating Revenue |
$115,000 |
$117,300 |
$119,646 |
$122,038.92 |
$124,479.70 |
$126,969.29 |
$129,508.68 |
Less: Production cost |
40,000 |
41,200 |
42,436 |
43,709.08 |
45,020.35 |
46,370.96 |
47,762.09 |
EBIT |
75,000 |
76,100 |
77,210 |
78,329.84 |
79,459.35 |
80,598.33 |
81,746.59 |
Less: Depreciation |
40,000 |
40,000 |
40,000 |
40,000.00 |
40,000.00 |
40,000.00 |
40,000.00 |
PBT |
35,000 |
36,100 |
37,210 |
38,329.84 |
39,459.35 |
40,598.33 |
41,746.59 |
Less: Tax @ 40 % |
14,000 |
14,440 |
14,884 |
15,331.94 |
15,783.74 |
16,239.33 |
16,698.63 |
Annual operating cash flow |
$49,000 |
$50,540 |
$52,094 |
$53,661.78 |
$55,243.08 |
$56,837.66 |
$58,445.22 |
Computation of NPV:
Year |
Cash Flow (C) |
PV factor computation |
PV factor @ 5 % (F) |
PV (= C x F) |
0 |
($280,000) |
1/(1+0.05)^0 |
1 |
($280,000.00000) |
1 |
$49,000.00 |
1/(1+0.05)^1 |
0.952380952 |
$46,666.66667 |
2 |
$50,540.00 |
1/(1+0.05)^2 |
0.907029478 |
$45,841.26984 |
3 |
$52,094.00 |
1/(1+0.05)^3 |
0.863837599 |
$45,000.75586 |
4 |
$53,661.78 |
1/(1+0.05)^4 |
0.822702475 |
$44,147.67592 |
5 |
$55,243.08 |
1/(1+0.05)^5 |
0.783526166 |
$43,284.40214 |
6 |
$56,837.66 |
1/(1+0.05)^6 |
0.746215397 |
$42,413.13786 |
7 |
$58,445.22 |
1/(1+0.05)^7 |
0.71068133 |
$41,535.92733 |
NPV |
$28,889.84 |
NPV of the project is $ 28,889.84
Mustang Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $280,000. The...
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