Question

Please show me your clear work. thank you so much!!

4) You are considering investing in a local business that modifies equipment & sells it to the public at a much higher price. You believe you can sell 4 units/ year with each modified unit selling for $25,000. You estimate the costs: labor & materials $10,000/unit, an initial $10,000 increase in NWC continuing for 4 yrs, lease expense for $15,000/yr, $60,000 in fixed assets (depreciate to zero salvage value) with expected MV of $10,000 at the end of the project. income tax rate = 34%, cap gains tax = 15%. What is the maximum price you would be willing to pay for the business if you require a 14% return on your investment?

Answer 1

Selling price per unit = $25,000 p.u.

Variable Cost per unit (labor & materials) = $10,000

Contribution per unit = 25,000 – 10,000 = $15,000

Annual Contribution = 15,000*4 units = $60,000

.

Cost of Fixed Assets = $60,000

Project Life = 4 years

Annual Depreciation = Cost of New Sausage system/ Project Life

= 60,000/4

= $15,000

.

.

Profit on sale of Sausage system at the end of project = Sales Price – Book Value

= 10,000 – 0

= $10,000

After Tax Salvage Value of Sausage system at the end of project = Profit on sale of Sausage system at the end of project*(1-Capital gain tax rate)

= 10.000*(1-0.15)

= 8,500

.

.Calculation of NPV of the project:

Year	Inititial Investment (1)	Working Capital (2)	Contribution from Sales (3)	Lease Expenses (4)	Depreciation (5)	Net Profit Before Tax = (6) = (3)-(4)-(5)	Tax @ 34% (7) = (6)*0.34	Net Profit after Tax (8) = (6)-(7)	Cash Flow from Operations (9) = (8)+(5)	After Tax Salavge Value (10)	Net Cash Flow (11) = (1)+(2)+(9)+(10)	DF Working	Discounting Factor @9% (12)	Present Value (13) = (11)*(12)
0	(60,000)	(10,000)	-	-	-	-	-	-	-	-	(70,000)	1	1	(70,000.00)
1	-	-	60,000	15,000	15,000	30,000	10,200	19,800	34,800	-	34,800	1/1.14^1	0.877192982	30,526.32
2	-	-	60,000	15,000	15,000	30,000	10,200	19,800	34,800	-	34,800	1/1.14^2	0.769467528	26,777.47
3	-	-	60,000	15,000	15,000	30,000	10,200	19,800	34,800	-	34,800	1/1.14^3	0.674971516	23,489.01
4	-	10,000	60,000	15,000	15,000	30,000	10,200	19,800	34,800	8,500	53,300	1/1.14^4	0.592080277	31,557.88
													NPV:	42,350.67

.

Therefore, maximum price we can pay for the project is its Net Present Value i.e.$42,350.67