Question

United Pigpen is considering a proposal to manufacture high-protein hog feed. The project would require use of an existing warehouse, which is currently rented out to a neighboring firm. The next year’s rental charge on the warehouse is $140,000, and thereafter, the rent is expected to grow in line with inflation at 4% a year. In addition to using the warehouse, the proposal envisages an investment in plant and equipment of $1.44 million. This could be depreciated for tax purposes straight-line over 10 years. However, Pigpen expects to terminate the project at the end of 8 years and to resell the plant and equipment in year 8 for $480,000. Finally, the project requires an immediate investment in working capital of $390,000. Thereafter, working capital is forecasted to be 10% of sales in each of years 1 through 7. Working capital will be run down to zero in year 8 when the project shuts down. Year 1 sales of hog feed are expected to be $5.00 million, and thereafter, sales are forecasted to grow by 5% a year, slightly faster than the inflation rate. Manufacturing costs are expected to be 90% of sales, and profits are subject to tax at 25%. The cost of capital is 12%.

What is the NPV of Pigpen’s project?

Answer 1

Outflow						All amount in $
Particulars	Year 0
Initial Investment	14,40,000.00
Working Capital	3,90,000.00
Opportunity Cost Warehouse Rent	1,40,000.00
Total	19,70,000.00
Inflow
Particulars	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8
Sales	50,00,000.00	52,50,000.00	55,12,500.00	57,88,125.00	60,77,531.25	63,81,407.81	67,00,478.20	70,35,502.11
Manufacturing Cost	45,00,000.00	47,25,000.00	49,61,250.00	52,09,312.50	54,69,778.13	57,43,267.03	60,30,430.38	63,31,951.90
Profit	5,00,000.00	5,25,000.00	5,51,250.00	5,78,812.50	6,07,753.13	6,38,140.78	6,70,047.82	7,03,550.21
Tax	1,25,000.00	1,31,250.00	1,37,812.50	1,44,703.13	1,51,938.28	1,59,535.20	1,67,511.96	1,75,887.55
Cash Profit after Tax (a)	3,75,000.00	3,93,750.00	4,13,437.50	4,34,109.38	4,55,814.84	4,78,605.59	5,02,535.87	5,27,662.66
working Capital forecast	5,00,000.00	5,25,000.00	5,51,250.00	5,78,812.50	6,07,753.13	6,38,140.78	6,70,047.82	0
Actual Working Capital	3,90,000.00	5,00,000.00	5,25,000.00	5,51,250.00	5,78,812.50	6,07,753.13	6,38,140.78
Cash Outflow/ (Inflow) for WC (b)	1,10,000.00	25,000.00	26,250.00	27,562.50	28,940.63	30,387.66	31,907.04	-6,70,047.82
Cash Inflow from Plant ( c)								4,80,000.00
Opportunity Cost (d)	5,600.00	5,824.00	6,056.96	6,299.24	6,551.21	6,813.26	7,085.79	7,369.22
Net Inflow (a-b+c-d)	2,59,400.00	3,62,926.00	3,81,130.54	4,00,247.64	4,20,323.01	4,41,404.67	4,63,543.04	16,70,341.26
Present Value of future cash Flows	23,93,013.39
Initial Investment	19,70,000.00
Net Present Value	4,23,013.39