Question

PlumYum Inc, a dried fruit producer in Massachusetts is investigating the feasibility introducing a new product: dried strawberry! The company has given you, the financial adviser for the company, the following information:   

• The estimated unit sales are 15000 packs in the first year, and 25000 packs in the second year.
• The project will end at the end of the second year.
• Each package will sell for $15 in the first year. When the competition catches up after two years, you anticipate that the price will drop to $12 for the second year.     
• The variable cost per unit is $4, and total fixed costs are $8,000 per year.   
• The equipment required to begin production is $300,000 and qualifies as seven-year MACRS property with depreciation rate of 14.29% in the first year, 24.49% in the second year, and 17.49% in the third year.     
• The equipment will be worth about 75 percent of its cost in three years and the relevant tax rate is 15 percent.
• The project will require $25,000 in net working capital at the start. Subsequently, total net working capital at the end of each year will be about 20 percent of sales for that year.

1. What is the Operating Cash Flow in year 2?

2. Find the NPV for this project assuming that the discount rate is 10%.

Answer 1

Statement showing depreciation

Year	Opeining balance	Depreciation rates	Deprecaition = depreciation rates x 300000	Closing balance
1	300000	14.29%	42870	257130
2	257130	24.49%	73470	183660
3	183660	17.49%	52470	131190

Statement showing NPV

Particulars	0	1	2	3	NPV = Sum of PV
Cost of equipment	-300000
Initial WC required	-25000
Selling price per unit		15	12
Variable cost per unit		4	4
Contribution per unit		11	8
Total units sold		15000	25000
Total contribution		165000	200000
Fixed cost		8000	8000
Depreciation		42870	73470
PBT		114130	118530
Tax @ 15%		17120	17780
PAT		97011	100751
Add: Depreciation		42870	73470
Annual operating cash flow	139881	174221
WC Requirement		-45000	70000
Terminal value (Note 1)				210929
Total cash flow	-325000	94881	244221	210929
PVIF @ 10%	1.0000	0.9091	0.8264	0.7513
PV	-325000.00	86255.00	201835.12	158473.70	121563.83

Note 1) Salvage value

Particulars	Amount
Salvage value of machine (300000*75%)	225000
Book Value	131190
Profit	93810
Tax @ 15%	14071.5
Cash inflow from sale of equipment (225000-14071.5)	210928.5

Thus

1) Operating cash flow at year 2 =174221 $

2) NPV = $121563.83