32. Project Evaluation [LO1] Aria Acoustics, Inc. (AAI), projects unit sales for

Question

32. Project Evaluation [LO1] Aria Acoustics, Inc. (AAI), projects unit sales for a new seven-octave voice emulation implant as follows: Production of the implants will require $1,500,000 in net working capital to start and additional net working capital investments each year equal to 15 percent of the projected sales increase for the following year. Total fixed costs are $3400,000 per year, variable production costs are $265 per unit, and the units are priced at $395 each. The equipment needed to begin production has an installed cost of $17,000,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS property. In five years, this equipment can be sold for about 20 percent of its acquisition cost AAI is in the 35 percent marginal tax bracket and has a required return on all its projects of 18 percent. Based on these preliminary project estimates, what is the NPV of the project? What is the IRR?

Explanation / Answer

Depreciation rates are taken from MACRS table using half year convention

NPV = Cashflow/(1+i)^n

where i is the rate of interest and n is the number of year.

IRR is that rate at which NPV is 0, So IRR = 47%

at 47% NPV is 0

Year Sales FC VC Sales Dep% Depreciation Increase in sales Additional Working capital Proceeds from sale of equipment Tax benefits from Depreciation Working capital Cash flow NPV at 18% 0        17,000,000          1,500,000 (18,500,000) (18,500,000) 1            84,000          3,400,000          22,260,000          33,180,000 14.29%          2,429,300              850,255        8,370,255        7,093,436 2            98,000          3,400,000          25,970,000          38,710,000 24.29%          4,129,300        5,530,000                   829,500          1,445,255        9,955,755        7,150,068 3          113,000          3,400,000          29,945,000          44,635,000 17.49%          2,973,300        5,925,000                   888,750          1,040,655     12,271,405        7,468,756 4          106,000          3,400,000          28,090,000          41,870,000 12.49%          2,123,300     (2,765,000)              743,155     12,011,905        6,195,607 5            79,000          3,400,000          20,935,000          31,205,000 8.93%          1,518,100 (10,665,000)          3,400,000              531,335          1,500,000     12,301,335        5,377,027 NPV     14,784,894

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