Question

Blue Jeans Corp. has done an analysis of whether to continue offering a new line of jeans or to halt operations, this analysis cost $250,000. The new product has expected sales at the end of this year of $800,000 and this grow every year by 3%. This product has created some cannibalization worth $75,000 of sales reduction each year. COGS is $200,000 at the end of this year and will also grow every year by 3%. COGS related to the cannibalized product is $25,000 each year. The line of jeans will be in production for three years, afterwards they become obsolete. The equipment cost of $2M ($2 million) was spent at the beginning of this year (t=0) and it has a 40% CCA rate. The space for the equipment could have received $10,000 each year in its next best alternative use. Interest charges are $50,000 annually. There will be a one-time net working capital increase of $20,000 at the end of year one; this will be recovered at the end of year 3. The firm demands a 5% return on projects such as this. The corporate tax rate is 30%. Assume that at the end of year 3 the equipment is sold for $0 and does not bring any tax consequences thereafter. What is the NPV of this project? A $584,434 B -$550,910 с $354,306 D$547,368 E $531,847

Answer 1

Ans) -$547368

Workings:

0 1 2 3 2250000 848720 824000 -206000 -212180 -50000 -50000 Year / Particulars Equipment Cost Revenue COGS Loss of Net Revenue Interest Charges Depreciation Net Profit Before Taxes Taxes Net Profit After Taxes 800000 -200000 -50000 -50000 -900000 -400000 -50000 -50000 -540000 -22000 -324000 212540 0 0 63762 - 400000 - 22000 148778 Add: Depreciation Add: Opportunity Cost Cash Inflow From Operations Increase in Working Capital Net Cash inflows 900000 110000 610000 20000 630000 540000 110000 628000 324000 110000 582778 -20000 562778 0 628000 PV factor @3.5% Present value of cash inflows 0.9662 608695.7 0.93351 586244.7 0.90194 507593.5 1702534 Sum of Present value of cash inflows Cash Outflows 2250000 NPV -547466

DC