1-Poulsen Industries is analyzing an average-risk project, and the following dat
ID: 2462619 • Letter: 1
Question
1-Poulsen Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no salvage value. This is just one of many projects for the firm, so any losses can be used to offset gains on other firm projects. The marketing manager does not think it is necessary to adjust for inflation since both the sales price and the variable costs will rise at the same rate, but the CFO thinks an adjustment is required. What is the difference in the expected NPV if the inflation adjustment is made vs. if it is not made?
2-Aggarwal Enterprises is considering a new project that has a cost of $1,000,000, and the CFO set up the following simple decision tree to show its three most likely scenarios. The firm could arrange with its work force and suppliers to cease operations at the end of Year 1 should it choose to do so, but to obtain this abandonment option, it would have to make a payment to those parties. How much is the option to abandon worth to the firm?
Explanation / Answer
Since the details are not mentioned in the sum about the sales and variable cost and other details, so extracted from other sources, so please find the detailed answer down with the figures given apart from the details given in the sum
WACC 10.0%
Net investment cost (depreciable basis) $200,000
Units sold 50,000
Average price per unit, Year 1 $25.00
Fixed operating costs exclusive depreciation (constant) $150,000
Variable operating cost/unit, Year 1 $20.20
Annual depreciation rate 33.333%
Expected inflation 4.00%
Tax rate 40.0%
With Inflation-NPV
Particulars
Year 1
Year 2
Year 3
Sales
12,50,000
13,00,000
13,52,000
Less:
Variable cost
10,10,000
10,50,400
10,92,416
Contibution
2,40,000
2,49,600
2,59,584
Less:
Fixed Cost
1,50,000
1,50,000
1,50,000
Depreciation
66,667
66,667
66,667
Profit Before tax
23,333
32,933
42,917
Less:tax
9,333
13,173
17,167
Profit after tax
14,000
19,760
25,750
Add:
Depreciation
66,667
66,667
66,667
Cash Flows
80,667
86,427
92,417
PV Factor
0.9091
0.8264
0.7513
Present value of Cash flows
73,333
71,427
69,434
Total Present value of Cash flows for 3 years
2,14,194
Less: Initial Investment
2,00,000
NPV
14,194
Without Inflation-NPV
Particulars
Year 1
Year 2
Year 3
Sales
12,50,000
13,00,000
13,52,000
Less:
Variable cost
10,10,000
10,10,000
10,10,000
Contribution
2,40,000
2,90,000
3,42,000
Less:
Fixed Cost
1,50,000
1,50,000
1,50,000
Depreciation
66,667
66,667
66,667
Profit Before tax
23,333
73,333
1,25,333
Less: tax
9,333
29,333
50,133
Profit after tax
14,000
44,000
75,200
Add:
Depreciation
66,667
66,667
66,667
Cash Flows
80,667
1,10,667
1,41,867
PV Factor
0.9091
0.8264
0.7513
Present value of Cash flows
73,333
91,460
1,06,587
Total Present value of Cash flows for 3 years
2,71,380
Less: Initial Investment
2,00,000
NPV
71,380
Difference in NPV=57,185
Particulars
Year 1
Year 2
Year 3
Sales
12,50,000
13,00,000
13,52,000
Less:
Variable cost
10,10,000
10,50,400
10,92,416
Contibution
2,40,000
2,49,600
2,59,584
Less:
Fixed Cost
1,50,000
1,50,000
1,50,000
Depreciation
66,667
66,667
66,667
Profit Before tax
23,333
32,933
42,917
Less:tax
9,333
13,173
17,167
Profit after tax
14,000
19,760
25,750
Add:
Depreciation
66,667
66,667
66,667
Cash Flows
80,667
86,427
92,417
PV Factor
0.9091
0.8264
0.7513
Present value of Cash flows
73,333
71,427
69,434
Total Present value of Cash flows for 3 years
2,14,194
Less: Initial Investment
2,00,000
NPV
14,194
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.