Amazing Manufacturing, Inc., has been considering the purchase of a new manufacturing facility for $540,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value at that time. Operating revenues from the facility are expected to be $410,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 2 percent. Production costs at the end of the first year will be $255,000, in nominal terms, and they are expected to increase at 3 percent per year. The real discount rate is 5 percent. The corporate tax rate is 25 percent.
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Real discount rate = (1+ nominal rate)/(1+ inflation rate) - 1
1+ nominal rate = (1+ Real discount rate) X ( 1+ Inflation rate )
1+ Nominal rate = (1+0.05) X (1.0.02)
1+ Nominal rate = = (1.05)(1.02)
1+ Nominal rate = = 1.071
Nominal rate = 0.071
ie 7.10%
Statement showing NPV
Particulars | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | NPV (Sum of PV) |
Purchase price | -540000.00 | ||||||||
Operating revenue | 410,000.00 | 418,200.00 | 426,564 | 435,095.28 | 443,797.19 | 452,673.13 | 461,726.59 | ||
Less: | |||||||||
Production cost | 255,000.00 | 262,650.00 | 270,529.50 | 278,645.39 | 287,004.75 | 295,614.89 | 304,483.34 | ||
Depreciation | 77,143.00 | 77,143.00 | 77,143.00 | 77,143.00 | 77,143.00 | 77,143.00 | 77,143.00 | ||
PBT | 77,857.00 | 78,407.00 | 78,891.50 | 79,306.89 | 79,649.64 | 79,915.24 | 80,100.25 | ||
Tax @ 25% | 19,464.25 | 19,601.75 | 19722.88 | 19,826.72 | 19,912.41 | 19,978.81 | 20,025.06 | ||
PAT | 58,392.75 | 58,805.25 | 59,168.62 | 59,480.17 | 59,737.23 | 59,936.43 | 60,075.19 | ||
Add: Depreciation | 77,143.00 | 77,143.00 | 77,143.00 | 77,143.00 | 77,143.00 | 77,143.00 | 77,143.00 | ||
Annual cash flow | 135,535.75 | 135,948.25 | 136,311.62 | 136,623.17 | 136,880.23 | 137,079.43 | 137,218.19 | ||
Total cash flow Round off | -540000.00 | 135,536.00 | 135,948.00 | 136,312.00 | 136,623.00 | 136,880.00 | 137,079.00 | 137,218.00 | |
PVIF @ 7.10% | 1.0000 | 0.9337 | 0.8718 | 0.8140 | 0.7600 | 0.7097 | 0.6626 | 0.6187 | |
PV | -540000.00 | 126,550.00 |
118,519.00 |
110,958.00 | 103,833.00 | 97,144.00 | 90,829.00 | 84,897.00 | 192,730.00 |
Thus NPV = $ 192,730.00
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