Question

10-11 X Example 1 We believe we can sell 60,000 home security devices per year at $140 a piece. They cost $100 to manufacture (variable cost). Fixed production costs run $205,000 per year. The necessary equipment costs $625,000 to buy and would be depreciated at a 25% CCA rate The equipment would have a zero salvage value after the five-year life of the project. We need to invest $160,000 in net working capital up front; no additional net working capital investment is necessary. The discount rate is 17%, and the tax rate is 38%. What do you think of the proposal? for solutions Notes - Comments E - :

Answer 1

Even before taking into account the cost of equipment: $625,000 and it's depriciation rate, you would want to confirm whether you can atleast cover your other costs. In the figure that is attached, Total revenue=60,000*140 for each year. subtract 30% of its value, and you would get effective Total revenue of 5208000 each year. the present value factor for 2nd year onwards would be (1/1.17)^t, where t is the time period. Multiply corresponding values, you would get Present value of Total revenue. The sum of total revenue would be $19494768.

similarly, pv of each year cost is calculated. total cost each year= 60,000*$100 plus $205,000 production cost. Thus, sum of present value of total cost would be $23226773.

Subtract total cost from total revenue, and you would get total profit, which is a negative number over the period of 5 years.

Thus, you should reject this business proposal.

NS E G H I к trpv vcpv profit pv 19494768 23226773 -3732005 AB D - year tr per year pv factor pv 1 5208000 - 5208000 2 5208000 0.85 4451282 3 5208000 0.73 3804515 4 5208000 0.62 3251722 5 5208000 0.53 2779249 fixed investment=160,000 . 1 2 3 4 5 tc per year pv factor pv 6205000 - 6205000 6205000 0.85 5303419 6205000 0.73 4532837 6205000 0.62 3874219 6205000 0.53 3311299 nmt in