We are evaluating a project that costs $969,000, has an fourteen-year life, and

Question

We are evaluating a project that costs $969,000, has an fourteen-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 157,000 units per year. Price per unit is $41, variable cost per unit is $23, and fixed costs are $984,504 per year. The tax rate is 37 percent, and we require a 12 percent return on this project. The projections given for price, quantity, variable costs, and fixed costs are all accurate to within +/- 16 percent.

Explanation / Answer

Here, to evaluate the profitability of the project, we calculate the Net Present value (NPV) as shown in the table below:

Since the NPV of the project at 12% is positive, the project is profitable and we should accept this project

Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Initial Cost -969000 Sales Revenue 6437000.00 6437000.00 6437000.00 6437000.00 6437000.00 6437000.00 6437000.00 6437000.00 6437000.00 6437000.00 6437000.00 6437000.00 6437000.00 6437000.0000 Varibale cost -3611000.00 -3611000.00 -3611000.00 -3611000.00 -3611000.00 -3611000.00 -3611000.00 -3611000.00 -3611000.00 -3611000.00 -3611000.00 -3611000.00 -3611000.00 -3611000.00 Fixed Costs -984504.00 -984504.00 -984504.00 -984504.00 -984504.00 -984504.00 -984504.00 -984504.00 -984504.00 -984504.00 -984504.00 -984504.00 -984504.00 -984504.00 Depreciation -69214.29 -69214.29 -69214.29 -69214.29 -69214.29 -69214.29 -69214.29 -69214.29 -69214.29 -69214.29 -69214.29 -69214.29 -69214.29 -69214.29 Profit before tax 1772281.71 1772281.71 1772281.71 1772281.71 1772281.71 1772281.71 1772281.71 1772281.71 1772281.71 1772281.71 1772281.71 1772281.71 1772281.71 1772281.71 Taxes at 37% -655744.23 -655744.23 -655744.23 -655744.23 -655744.23 -655744.23 -655744.23 -655744.23 -655744.23 -655744.23 -655744.23 -655744.23 -655744.23 -655744.23 Profit after tax 1116537.48 1116537.48 1116537.48 1116537.48 1116537.48 1116537.48 1116537.48 1116537.48 1116537.48 1116537.48 1116537.48 1116537.48 1116537.48 1116537.48 Add back depreciation 69214.29 69214.29 69214.29 69214.29 69214.29 69214.29 69214.29 69214.29 69214.29 69214.29 69214.29 69214.29 69214.29 69214.29 Net Cash flow -969000 1185751.77 1185751.77 1185751.77 1185751.77 1185751.77 1185751.77 1185751.77 1185751.77 1185751.77 1185751.77 1185751.77 1185751.77 1185751.77 1185751.77 NPV at 12% $ 6,071,637.23

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