Question

A business opportunity has presented itself to you and one of your classmates. Your opportunity is to enter the fast growing craft beer industry. Your projected sales in the first year is 7500 kegs. Your projected growth rate is 8 percent. Entering the business will require $35,000 of net working capital. Total fixed costs are $95,000. Variable production costs are $30 per keg and keg sales are priced at $55 each. The equipment to begin production is $175,000. The equipment will be depreciated using straight line depreciation over a five year life and has no salvage value. The tax rate is 34 percent and the required return is 25 percent. What is the NPV of the project and should you pursue the project?

Answer 1

Initial investment Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 $175,000 $35,000 Total $210,000 210,000 Equipment Working capital Initial investment Sales volume (kgs) Price per kg Revenue Less: Variable cost S30 per kg Less: Fixed costs Less: Depreciation per year Profit before tax Less: Tax@34% Net Income Add: Depreciation Free Cash flow S7,500 $8,100$8,748 $9,448 $10,204 S55 S412,500 $445,500 $481,140 $519,631 $561,202 S225,000 $243,000 $262,440 $283,435 $306,110 S95,000 $95,000 $95,000 $95,000 S95,000 S35,000 S35,000 S35,000 $35,000 S35,000 S57,500 S72,500 $88,700 $106,196 $125,092 S19,550$24,650 S30,158 S36,107 $42,531 S37,950 $47,850 $58,542 $70,089 $82,561 S35,000 S35,000 $35,000 $35,000 $35,000 210,000 $72,950 $82,850 $93,542 $105,089 $117,561 S55 S55 S55 S55 Life of equipment (in yrs) Depreciation per year S35,000 NPV@25% $24,675.47