Locus Quintatus, Inc., a highly profitable maker of customized chariots, is plan

Question

Locus Quintatus, Inc., a highly profitable maker of customized chariots, is planning to introduce a new model shortly. The project will have a 4-year life. The firm must purchase equipment immediately at a cost $900,000. Freight and installation costs for this equipment will be $100,000. The equipment will be depreciated as a 3-year class asset under MACRS. At the end of year 4, the equipment will be sold for $20,000. During the first year, Locus will have incremental operation expenses of $300,000 that are attributable to this project. Locus expects to be able to sell 2,000 chariots per year during years 2 through 4 at an average price of $800 each and to incur operating expenses that include variable costs equal to 40% of the sales price and fixed cost equal to $400,000 annually. Also, Locus expects its net working capital investment will increase by $50,000 during year 2 and be recovered at the end of year 4. (Assume all operating costs and revenue are incurred at the end of each year.) The marginal tax rate for Locus is 40 percent and the weighted average cost of capital is 12 percent. What is the required net investment and the Net Present Value? The 3-year MACRS schedule is: 33.33%, 44.45%, 14.81%, 7.41%. (Round numbers to thousands)

Explanation / Answer

Initial Investment = Machine Cost + Freight & Installation Cost

Initial Investment = 900000 + 100000

Initial Investment = $ 1000000

Depreciation in Year 1 = 1000000*33.33% = 333300

Depreciation in Year 2 = 1000*44.45% = 444500

Depreciation in Year 3 = 1000*14.81% = 148100

Depreciation in Year 4 = 1000*7.41% = 74100

Cash flow in Year 1 = - 300000*(1-40%) + 333300*40% = - $ 46680

Cash flow in Year 2 = (2000*(800-40%*800)- 400000)*(1-40%) + 444500*40% - 50000 = $ 463800

Cash flow in Year 3 = (2000*(800-40%*800)- 400000)*(1-40%) + 148100*40% = $ 395240

Cash flow in Year 4 = (2000*(800-40%*800)- 400000)*(1-40%) + 74100*40% + 50000 + 20000*(1-40%) = $ 427640

Net Present Value = -1000000 - 46680/1.12 + 463800/1.12^2 + 395240/1.12^3 + 427640/1.12^4

Net Present Value = - $ 118,843.10

(Round numbers to thousands)

Net Present Value = - $ 119,000

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