4. (10 points) (Ignore income taxes in this problem.) Axillar Beauty Products Co

Question

4. (10 points) (Ignore income taxes in this problem.) Axillar Beauty Products Corporation is considering the production of a new conditioning shampoo which will require the purchase of new mixing machinery. The machinery will cost $310,000, is expected to have a useful life of 10 years, and is expected to have a salvage value of $35,000 at the end of 10 years. The machinery will also need a $25,000 overhaul at the end of year 6. A $40,000 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 $80,000 per year for each of the 10 years. Axillar's discount rate is 14%. Required: a. What is the net present value of this investment opportunity? b. Based on your answer to (a) above, should Axillar go ahead with the new conditioning shampoo?

Explanation / Answer

PV of cash outflow

Initial machinery cost = $310000

Year 6 Overhaul required = $25000*0.455586546 = $11389.66365

Working capital required = $40000

Therefore, PV of cash outflow = $310000+$11389.66365+$40000 = $361389.6636

PV of cash inflow

Year 1 to 10 = $80000 * Annualised discounting rate of 14% for 10 years = $80000*5.216115632 = $417289.2505

In year 10 machinery will have salvage value of $35000 plus release of working capital of $40000 = $75000*0.269743807 = $20230.78552

Total PV of cash inflow =$417289.2505+$20230.78552 = $437520.036

NPV = $437520.036 - $361389.6636 = $76130.3724

Axillar should go ahead with the new conditioning shampoo since NPV is positive

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