Question

The Bruin's Den Outdoor Gear is considering a new 7-year project to produce a new tent line. The equipment necessary would cost $1.99 million and be depreciated using straight-line depreciation to a book value of zero. At the end of the project, the equipment can be sold for 10 percent of its initial cost. The company believes that it can sell 31,000 tents per year at a price of $79 and variable costs of $38 per tent. The fixed costs will be $545,000 per year. The project will require an initial investment in net working capital of $253,000 that will be recovered at the end of the project. The required rate of return is 12.2 percent and the tax rate is 35 percent. What is the NPV? ( 8 02:57:00

Answer 1

NPV = present value of cash flows - initial investment - investment in net working capital

present value of cash flows = year 1 net cash flow/(1+required return) + year 2 net cash flow/(1+required return)2 + year 3 net cash flow/(1+required return)3 .... + year 7 net cash flow/(1+required return)7

book value at the end of project's life is zero. so, tax on sale of equipment will be applicable on entire sale value.

NPV is $519,084.61 or rounded off to $519,085.

	Years	0	1	2	3	4	5	6	7
	Initial investment	-$1,990,000	0	0	0	0	0	0	0
	net working capital investment	-$253,000	0	0	0	0	0	0	0
	no. of tents to be sold	0	31,000	31,000	31,000	31,000	31,000	31,000	31,000
	Selling price per tent	0	$79	$79	$79	$79	$79	$79	$79
	Variable cost per tent	0	$38	$38	$38	$38	$38	$38	$38
	Sales	$0.00	$2,449,000.00	$2,449,000.00	$2,449,000.00	$2,449,000.00	$2,449,000.00	$2,449,000.00	$2,449,000.00
Less:	Variable cost	$0.00	$1,178,000.00	$1,178,000.00	$1,178,000.00	$1,178,000.00	$1,178,000.00	$1,178,000.00	$1,178,000.00
Less:	Fixed costs	$0.00	$545,000.00	$545,000.00	$545,000.00	$545,000.00	$545,000.00	$545,000.00	$545,000.00
Less:	Depreciation	$0.00	$284,285.71	$284,285.71	$284,285.71	$284,285.71	$284,285.71	$284,285.71	$284,285.71
	Cash flows before-tax	$0.00	$441,714.29	$441,714.29	$441,714.29	$441,714.29	$441,714.29	$441,714.29	$441,714.29
Less:	Taxes @35%	$0.00	$154,600.00	$154,600.00	$154,600.00	$154,600.00	$154,600.00	$154,600.00	$154,600.00
	Cash flows after-tax	$0.00	$287,114.29	$287,114.29	$287,114.29	$287,114.29	$287,114.29	$287,114.29	$287,114.29
Add back:	Depreciation	$0.00	$284,285.71	$284,285.71	$284,285.71	$284,285.71	$284,285.71	$284,285.71	$284,285.71
Add back:	working capital recovery	$0.00	$0.00	$0.00	$0.00	$0.00	$0.00	$0.00	$253,000.00
Add:	Sale value of equipment	$0.00	$0.00	$0.00	$0.00	$0.00	$0.00	$0.00	$199,000.00
Less:	Tax on sale value	$0.00	$0.00	$0.00	$0.00	$0.00	$0.00	$0.00	$69,650.00
	Net cash flows	-$2,243,000.00	$571,400.00	$571,400.00	$571,400.00	$571,400.00	$571,400.00	$571,400.00	$953,750.00
	NPV	$519,084.61

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