You have been asked whether you firm should go ahead with a project to manufacto
ID: 2483275 • Letter: Y
Question
You have been asked whether you firm should go ahead with a project to manufactory and sell socks. You have hired a consultant who conducted a marketing study. She estimates the first year sales should be $1 million then sales should grow by 15% per year for the next three year after that. She was paid $50,000 for her report. The cost of the equipment to manufacture the socks is $200,000. Your company will depreciate the equipment using a 3-year MACRS depreciation schedule. The equipment will be sold at the end of 4 years and the projected sale price is $50,000. Your marketing department has told you than the cost of sales is 85% (Includes Cost of Goods sold and GSA) and that the project will require an investment in working capital of 10% of sales (assume it is needed at the beginning of the year and you recover it at the end of the project). You accounting department has told you that the tax rate is 40% and that the proper discount rate for the project is 12.00%. What is the NPV of the project? What are the IRR and MIRR of the project? Should the firm take the project? Why?
Explanation / Answer
The following assumptions will be used for calculating the NPV of the project
The assets value is $200,000
The consultant fee is $50,000 at end of 4 years
The cost of capital is 12%
The depreciation is on 3 years MACRS depreciation schedule
The tax rate is 40%
The salvage value of new equipment is $ 50,000 at the end of the 4 years
The sales revenue is $1000,000 in first year than growth at 115% per year from year 2 to 4
The cost ofsales is 85%of sales
The working capital required i.e cash outflow is 10% if sale every year at the beginning of every year
The cash inflow of working capital required is recovered at the end of year 4for all years
the calculation of NPV on the basis of above assumptions
the NPV is negative as such project should not be taken
NPV calculation year equipment cost Cash inflows working capital recovered Depreciation of new asset MACRS 3 year schudule cost of sales 85% of sales working capital @ 10% savings before tax tax @.40 savings after tax add -: deprecition annual cash inflow pV factor @12% cash inflow at present value 200000 1 100,000.00 66,660.00 85,000.00 10,000.00 (61,660.00) - (61,660.00) 66,660.00 5,000.00 0.89286 4,464.29 2 115,000.00 88,900.00 97,750.00 11,500.00 (83,150.00) - (83,150.00) 88,900.00 5,750.00 0.79719 4,583.86 3 132,250.00 29,620.00 112,412.50 13,225.00 (23,007.50) - (23,007.50) 29,620.00 6,612.50 0.71178 4,706.65 4 152,087.50 49,933.75 14,820.00 129,274.38 15,208.75 42,718.13 17,087.25 25,630.88 14,820.00 40,450.88 0.63552 25,707.26 39,462 Present value of cash inflows for 4 years 39,462 present value of scrap value at end of 4 years (50,000 x 0.633518 31776 present value of total cash inflow 71,238 less present value of cash outflow equipment 200000 present value of consulatnst fees paid at end of 4 years(50000 x 0.635518) 31776 Total cash outflow 231776 Net NPV (160,538)Related Questions
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