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Amazing Manufacturing, Inc., has been considering the purchase of a new manufacturing facility for $490,000. 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 $385,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 5 percent. Production costs at the end of the first year will be $230,000, in nominal terms, and they are expected to increase at 6 percent per year. The real discount rate is 8 percent. The corporate tax rate is 25 percent. |
| Calculate the NPV of the project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) |
First of all lets convert real discount rate into nominal rate
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+0.08) X (1.0.05)
1+ Nominal rate = = (1.08)(1.05)
1+ Nominal rate = = 1.1340
Nominal rate = 0.1340
ie 13.4%
Statement showing NPV
| Particulars | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
NPV (Sum of PV) |
| Purchase price | -490000.00 | ||||||||
| Operating revenue | 385000.00 | 404250.00 | 424462.50 | 445685.63 | 467969.91 | 491368.40 | 515936.82 | ||
| Less: | |||||||||
| Production cost | 230000.00 | 243800.00 | 258428.00 | 273933.68 | 290369.70 | 307791.88 | 326259.40 | ||
| Depreciation | 70000.00 | 70000.00 | 70000.00 | 70000.00 | 70000.00 | 70000.00 | 70000.00 | ||
| PBT | 85000.00 | 90450.00 | 96034.50 | 101751.95 | 107600.21 | 113576.52 | 119677.43 | ||
| Tax @ 25% | 21250.00 | 22612.50 | 24008.63 | 25437.99 | 26900.05 | 28394.13 | 29919.36 | ||
| PAT | 63750.00 | 67837.50 | 72025.88 | 76313.96 | 80700.15 | 85182.39 | 89758.07 | ||
| Add: Depreciation | 70000.00 | 70000.00 | 70000.00 | 70000.00 | 70000.00 | 70000.00 | 70000.00 | ||
| Annual cash flow | 133750.00 | 137837.50 | 142025.88 | 146313.96 | 150700.15 | 155182.39 | 159758.07 | ||
| Total cash flow | -490000.00 | 133750.00 | 137837.50 | 142025.88 | 146313.96 | 150700.15 | 155182.39 | 159758.07 | |
| PVIF @ 13.4% | 1.0000 | 0.8818 | 0.7776 | 0.6857 | 0.6047 | 0.5333 | 0.4702 | 0.4147 | |
| PV | -490000.00 | 117945.33 | 107186.79 | 97393.13 | 88477.64 | 80361.57 | 72973.32 | 66247.79 | 140585.58 |
Thus NPV = $ 140585.58
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