Question

BASIC INFORMATION: A three-year project will cost $60,000 to construct. This will be depreciated straight-line to zero over the three-year life. The price per unit sold is $20 and the variable cost per unit sold is $10. Fixed costs are $30,000 per year.

In addition to the BASIC INFORMATION, you find that a salvage company will pay you $10,000 for the assets at the end of year 3. The project will require an investment of $10,000 up front for net working capital. If you expect to sell 7,000 units per year, compute the NPV assuming a required return of 15% and a tax rate of 30%.
A. Less than $0
B. $11,347
C. $14,416
D. $18,807
E. More than $20,000

The answer is D, please show all the steps, thanks!

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

C D E Year 1 2 3 Project Cost Initial NWC 0 -$60,000.00 -$10,000.00 Sale unit Sale Price Variable cost per unit $7,000.00 $20.00 $10.00 $7,000.00 $20.00 $10.00 $7,000.00 $20.00 $10.00 Revenue Cost 12 13 Fixed cost Depreciation EBT Tax (30%) Net Income $140,000.00 $70,000.00 $30,000.00 $20,000.00 $20,000.00 $6,000.00 $14,000.00 $140,000.00 $70,000.00 $30,000.00 $20,000.00 $20,000.00 $6,000.00 $14,000.00 $140,000.00 $70,000.00 $30,000.00 $20,000.00 $20,000.00 $6,000.00 $14,000.00 After tax salvage value age value NWC recovered $7,000.00 $10,000.00 After tax Cash Flow | $70,000.00 $34,000.00 $34,000.00 $51,000.00 Required return 15% NPV of Project $18,807

Cell reference -

A B C D DE F Year 1 2 3 Project Cost Initial NWC 0 -60000 -10000 Sale unit Sale Price Variable cost per unit 7000 20 10 7000 20 10 7000 20 10 9. 10 11 14 Revenue Cost Fixed cost Depreciation ЕВТ Tax (30%) Net Income =D7*D8 =E7*E8 =F7*F8 =D7*D9 =E7*E9 =F7*F9 30000 30000 30000 --$C$4/3 --$C$4/3 --$C$4/3 |=D11-SUM(D12:014) =E11-SUM(E12:E14) 1=F11-SUM(F12:F14) | =D15*0.3 =E15*0.3 F15*0.3 =D15-D16 =E15-E16 =F15-F16 After tax salvage value NWC recovered =10000*(1-0.3) =-C5 After tax Cash Flow =SUM(C4:05) =D17+D14 =E17+E14 =F17+F14+F19+F20 Required return 0.15 NPV of Project =C22+NPV(C24,D22:F22)

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.