Question

You are evaluating a project for The Tiff-any golf club, guaranteed to correct that nasty slice. You estimate the sales price of The Tiff-any to be $430 per unit and sales volume to be 1,200 units in year 1; 1,325 units in year 2; and 1,000 units in year 3. The project has a 3-year life. Variable costs amount to $240 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $156,000 in assets, which will be depreciated straight-line to zero over the 3-year project life. The actual market value of these assets at the end of year 3 is expected to be $32,000. NWC requirements at the beginning of each year will be approximately 20 percent of the projected sales during the coming year. The tax rate is 30 percent and the required return on the project is 11 percent.

Answer 1

Sales price per unit of the product = $430 p.u.

Variable Cost per unit of the product = $240 p.u.

Contribution p.u of the product = Sales price per unit - Variable Cost per unit

= 430 – 240

= $190 p.u.

.

Fixed Cost per year = $100,000 per year

.

Initial Investment in Assets = 156,000

Depreciation every year = 156,000/3 = $52,000 every year for 3 years

Net Working Capital required & Inflow and Outflow from Working Capital (calculated in Table below):

Year	Sales Units (1)	Sales price p.u. (2)	Total Sales Value ($) = (1)*(2)	Working Capital required at the beginning of each year	Inflow/Outflow of Working Capital
0				103,200	(103,200)
1	1200	430	516,000	113,950	(10,750)
2	1325	430	569,750	86,000	27,950
3	1000	430	430,000	-	86,000

After Tax Salvage value on sale of asset = Profit on sale of Asset*(1-Tax Rate)

= (32,000-0)*(1-0.30)

= $22,400

.

Calculation of NPV:

Year	Initial Investment (1)	Contribution p.u. (2)	Sales Units (3)	Total Contribution (4) = (2)*(3)	Fixed Cost (5)	Depreciation(6)	Profit Before Tax(7) = (4)-(5)-(6)	Tax (8)= (7)*30%	Profit after Tax (9) = (7)-(8)	Cash Flow from Opeations(10) = (9)+(6)	Working Capital (11)	Salavge Value (12)	Net Cash Flow (13) = (1) + (10) + (11)+(12)	DF Working	Discounting Factor (14)	Present Value(15) = (13)*(14)
0	-156000										(103,200)		(259,200)	1	1	(259,200)
1	0	190	1,200	228,000	100,000	52,000	76,000	22,800	53,200	105,200	(10,750)		94,450	1/1.11^1	0.900900901	85,090
2	0	190	1,325	251,750	100,000	52,000	99,750	29,925	69,825	121,825	27,950		149,775	1/1.11^2	0.811622433	121,561
3	0	190	1,000	190,000	100,000	52,000	38,000	11,400	26,600	78,600	86,000	22,400	187,000	1/1.11^3	0.731191381	136,733
															NPV:	84,184

Company should invest in the project since NPV is positive .Project is viable.