Marsha Jones has bought a used Mercedes horse transporter for her Connecticut estate. It cost $35,000. The object is to save on horse transporter rentals.
Marsha had been renting a transporter every other week for $200 per day plus $1.00 per mile. Most of the trips are 80 or 100 miles in total. Marsha usually gives the driver a $40 tip. With the new transporter she will only have to pay for diesel fuel and maintenance, at about $.45 per mile. Insurance costs for Marsha’s transporter are $1,200 per year.
The transporter will probably be worth $15,000 (in real terms) after eight years, when Marsha’s horse Nike will be ready to retire. Is the transporter a positive-NPV investment? Assume a nominal discount rate of 9% and a 3% forecasted inflation rate. Marsha’s transporter is a personal outlay, not a business or financial investment, so taxes can be ignored.
| 2009 | 2010 | 2011 | 2012-2013 |
1.Capital expenditure | −10,400 |
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2.Research and development | −2,000 |
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3.Working captial | −4,000 |
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4.Revenue |
| 8,000 | 16,000 | 40,000 |
5.Opearting costs |
| −4,000 | −8,000 | −20,000 |
6.Overhead |
| −800 | −1,600 | −4,000 |
7.Depreciation |
| −1,040 | −1,040 | −1,040 |
8.Interest |
| −2,160 | −2,160 | −2,160 |
9.Income | −2,000 | 0 | 3,200 | 12,800 |
10.Tax | 0 | 0 | 420 | 4,480 |
11.Net cash flow | −16,400 | 0 | 2,780 | 8,320 |
12.Net present value = + 13,932 |
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TABLE 6.7 Cash flows present value Relliable Electric’s Proposed investment(&thousands).
See Problem 19.
Notes:
1. Capital expenditure: $8 million for new machinery and $2.4 million for a warehouse extension. The full cost of the extension has been charged to this project, although only about half of the space is currently needed. Since the new machinery will be housed in an existing factory building, no charge has been made for land and building.
2. Research and development: $1.82 million spent in 2008. This figure was corrected for 10% inflation from the time of expenditure to date.Thus 1.82×1.1=$2 million.
3. Working capital: Initial investment in inventories.
4. Revenue: These figures assume sales of 2,000 motors in 2010, 4,000 in 2011, and 10,000 per year from 2012 through 2019. The initial unit price of $4,000 is forecasted to remain constant in real terms.
5. Operating costs: These include all direct and indirect costs. Indirect costs (heat, light, power, fringe benefits, etc.) are assumed to be 200% of direct labor costs. Operating costs per unit are forecasted to remain constant in real terms at $2,000.
6. Overhead: Marketing and administrative costs, assumed equal to 10% of revenue.
7. Depreciation: Straight-line for 10 years.
8. Interest: Charged on capital expenditure and working capital at Reliable’s current borrowing rate of 15%.
9. Income: Revenue less the sum of research and development, operating costs, overhead, depreciation, and interest.
10. Tax: 35% of income. However, income is negative in 2009. This loss is carried forward and deducted from taxable income in 2011.
11. Net cash flow: Assumed equal to income less tax.
12. Net present value: NPV of net cash flow at a 15% discount rate.
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