Question

Q3. (25 marks) A project requires an initial fixed asset investment of $600,000, which will be depreciated straight-line to zero over the six-year life of the project. The pre-tax salvage value of the fixed assets at the end of the project is estimated to be $50,001. Projected sales volume for each year of the project is shown below. The sale price is $50 per unit for the first three years, and $45 per unit for years 4 through 1. A $30,000 initial investment in net working capital is required, with additional investments equal to 7.5% of annual sales for each year of the project. Variable costs are $35 per unit, and fixed costs are $50,000 per year. The firm has a tax rate of 34% and a required return on investment of 12%. Year Sales 1 10,000 2 12,500 3 15,625 4 19,531 5 24,414 6 30,518 Calculate NPV by showing detailed calculations.

Answer 1

CALCULATION OF NET PRESENT VALUE
Year	Initial Investment (Fixed Asset)	Working Capital (Sales x 7.5%)	Net Income after tax	Tax Savings on depreciation	Post tax Salvage Value (50,001 - 34%)	Total Cashflow	PVF @ 12%	Net Present Value
0	(600,000)	(30,000)	-	-	-	(630,000)	1	(630,000)
1	-	(37,500)	45,430	31,167	-	39,097	0.8929	34,908
2	-	(46,875)	70,180	31,167	-	54,472	0.7972	43,425
3	-	(58,594)	101,117	31,167	-	73,691	0.7118	52,451
4	-	(65,917)	75,334	31,167	-	40,584	0.6355	25,792
5	-	(82,397)	107,562	31,167	-	56,332	0.5674	31,964
6	-	(102,998)	147,849	31,167	33,001	109,018	0.5066	55,232
								(386,228)
Calculation of Net Income after tax
Particulars	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Selling Price per unit		50	50	50	45	45	45
Less: Variable Cost per unit	(35)	(35)	(35)	(35)	(35)	(35)
Contribution per unit		15	15	15	10	10	10
Number of units sold		10,000	12,500	15,625	19,531	24,414	30,518
Total Contribution		150,000	187,500	234,375	195,310	244,140	305,180
Less: Fixed Costs		(50,000)	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)
Less: Depreciation		(31,167)	(31,167)	(31,167)	(31,167)	(31,167)	(31,167)
Net Income before tax		68,833	106,333	153,208	114,143	162,973	224,013
Less: Tax @ 34%		(23,403)	(36,153)	(52,091)	(38,809)	(55,411)	(76,164)
Net Income after tax		45,430	70,180	101,117	75,334	107,562	147,849
Tax Savings on depreciation
Depreciation = (600,000 - 50,001)/6 = $ 91,667
Tax savings on depreciation = 91,667 x 34% = $ 31,167