(Ignore income taxes in this problem.) Sampson Beauty Products Corporation is co
ID: 2415722 • Letter: #
Question
(Ignore income taxes in this problem.) Sampson Beauty Products Corporation is considering the production of a new conditioning shampoo that will require the purchase of new mixing machinery. The machinery will cost $550,000, is expected to have a useful life of 10 years, and is expected to have a salvage value of $55,000 at the end of 10 years. The machinery will also need a $35,000 overhaul at the end of Year 5. A $50,000 increase in working capital will be needed for this investment project. The working capital will be released at the end of the 10 years. The new shampoo is expected to generate net cash inflows of 95,000 per year for each of the 10 years. Sampson's discount rate is 16%.
Items
Year(s)
Amount
16% Factor
Present Value
Cost of machinery
Now
($550,000)
1
($550,000)
Working capital increase
Now
($50,000)
1
($50,000)
Annual cash inflows
1–10
$95,000
4.833
459,135
Overhaul
5
($35,000)
0.476
($16,660)
Salvage value
10
$55,000
0.227
12,485
Working capital release
10
$50,000
0.227
11,350
Net present value
($133,690)
Required:
What is the net present value of this investment opportunity?
Based on your answer to (a) above, should Sampson go ahead with the new conditioning shampoo?
Items
Year(s)
Amount
16% Factor
Present Value
Cost of machinery
Now
($550,000)
1
($550,000)
Working capital increase
Now
($50,000)
1
($50,000)
Annual cash inflows
1–10
$95,000
4.833
459,135
Overhaul
5
($35,000)
0.476
($16,660)
Salvage value
10
$55,000
0.227
12,485
Working capital release
10
$50,000
0.227
11,350
Net present value
($133,690)
Explanation / Answer
Initial Investment = Cost of machine + Working capital investment = 550000 + 50000 = 600000
Present value of Annual Cash Flows = 95000 * PVIFA( 10 yr , 16%) = 95000 * 4.833 = 459135
Present value of terminal value = ( Salvage value + Working capital released) * PVIF( 10 yr , 16%)
Present value of terminal value = ( 55000 + 50000) * 0.2267 = 23804
Present value of Overhaul at year 5 = 35000 * PVIF ( 5 , 16%) = 35000 * 0.4761 = 16664
Net presnt value = Present value of annual cash flow + Present value of terminal value - Present value of overhaul - Initial Invetment = 459135 + 23804 - 16664 - 600000 = - 133725
The difference in NPV is due to PVIF and PVIFA factors being rounded off in your calculations
The investment in this project is not viable since it has a negative NPV and it will destro shareholders wealth. Hence Sampson shoild not go ahead with the new conditioning shampoo
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