Desai Industries is analyzing an average-risk project, and the following data ha

Question

Desai Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no salvage value. This is just one of many projects for the firm, so any losses can be used to offset gains on other firm projects. What is the project's expected NPV?

WACC 10.0%
Net investment cost (depreciable basis) $200,000
Units sold 50,000
Average price per unit, Year 1 $25.00
Fixed operating cost excluding depreciation (constant) $150,000
Variable operating cost/unit, Year 1 $20.20
Annual depreciation rate 33.333%
Expected inflation rate per year 5.00%
Tax rate 40.0%

a. $15,925
b. $16,764
c. $17,646
d. $18,528
e. $19,455

Explanation / Answer

c. $17,646
Working: Year - 1 Year - 2 Year - 3 Net Investment 200000 200000 200000 Sales (50000 * 25) 1250000 1312500 1378125 Less: Variable Cost (50000 * 20.2) 1010000 1060500 1113525 Contribution: 240000 252000 264600 Less: Fixed Operating Costs 216660 216660 216660 23340 35340 47940 Less: Tax (Operating income*40%) 9336 14136 19176 Net Income 14004 21204 28764 Add: Depreciation (200000 * 33.33%) 66660 66660 66660 Income Before Depreciation After Tax: 80664 87864 95424 Cash Present Value Inflows WACC 10% of Cash inflows Year - 1 80664 0.909090909 73330.90909 Year - 2 87864 0.826446281 72614.87603 Year - 3 95424 0.751314801 71693.46356 Present Value of Cash Inflows 217639.2487 Less: Investment 200000 Net Present Value 17639.24869 WACC 10% formula: 1 year =1/1.1^1 2 year =1/1.1^2 3 year =1/1.1^3 Inflation Sales = Previous Sales * 105% Iflation Expenses = Previou Expenses * 105% Year - 1 Year - 2 Year - 3 Net Investment 200000 200000 200000 Sales (50000 * 25) 1250000 1312500 1378125 Less: Variable Cost (50000 * 20.2) 1010000 1060500 1113525 Contribution: 240000 252000 264600 Less: Fixed Operating Costs 216660 216660 216660 23340 35340 47940 Less: Tax (Operating income*40%) 9336 14136 19176 Net Income 14004 21204 28764 Add: Depreciation (200000 * 33.33%) 66660 66660 66660 Income Before Depreciation After Tax: 80664 87864 95424 Cash Present Value Inflows WACC 10% of Cash inflows Year - 1 80664 0.909090909 73330.90909 Year - 2 87864 0.826446281 72614.87603 Year - 3 95424 0.751314801 71693.46356 Present Value of Cash Inflows 217639.2487 Less: Investment 200000 Net Present Value 17639.24869 WACC 10% formula: 1 year =1/1.1^1 2 year =1/1.1^2 3 year =1/1.1^3 Inflation Sales = Previous Sales * 105% Iflation Expenses = Previou Expenses * 105%
Thank you.... Year - 1 Year - 2 Year - 3 Net Investment 200000 200000 200000 Sales (50000 * 25) 1250000 1312500 1378125 Less: Variable Cost (50000 * 20.2) 1010000 1060500 1113525 Contribution: 240000 252000 264600 Less: Fixed Operating Costs 216660 216660 216660 23340 35340 47940 Less: Tax (Operating income*40%) 9336 14136 19176 Net Income 14004 21204 28764 Add: Depreciation (200000 * 33.33%) 66660 66660 66660 Income Before Depreciation After Tax: 80664 87864 95424 Cash Present Value Inflows WACC 10% of Cash inflows Year - 1 80664 0.909090909 73330.90909 Year - 2 87864 0.826446281 72614.87603 Year - 3 95424 0.751314801 71693.46356 Present Value of Cash Inflows 217639.2487 Less: Investment 200000 Net Present Value 17639.24869 WACC 10% formula: 1 year =1/1.1^1 2 year =1/1.1^2 3 year =1/1.1^3 Inflation Sales = Previous Sales * 105% Iflation Expenses = Previou Expenses * 105%

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