Domenico Raoelli Corporation (DRC) is considering a project where they would ope

Question

Domenico Raoelli Corporation (DRC) is considering a project where they would open a new facility in Seattle, Washington. The DRC’s Project Manager, Mrs. Laura Paoli, has assembled the following information regarding the proposed project:

• It would cost $500,000 today (at t = 0) to construct the new facility. The cost of the facility will be depreciated on a straight-line basis over five years.
• If DRC opens the facility, it will need to increase its inventory by $100,000 at t = 0. $70,000 of this inventory will be financed with accounts payable.
• The Project Manager has estimated that the project will generate the following amount of revenue over the next three years:

Year 1 Revenue = $1.0 million
Year 2 Revenue = $1.2 million
Year 3 Revenue = $1.5 million

• Operating costs excluding depreciation equal 70% of revenue.
• DRC plans to abandon the facility after three years. At t = 3, the project’s estimated salvage value will be $200,000. At t = 3, DRC will also recover the net operating working capital investment that it made at t = 0.
• The project’s cost of capital is 14%.
• The DRC’s tax rate is 40%.

What is the project’s net present value (NPV)?

Explanation / Answer

Calculation of Cash flows: Revenue Operating costs(OC) Depreciation EBIT = Revenue - OC Taxes 40% Net income Cash flows= Dep + Net income 1 $1,000,000 $700,000 $100,000 $300,000 $120,000.0 $180,000.0 $280,000.0 2 $1,200,000 $840,000 $100,000 $360,000 $144,000.0 $216,000.0 $316,000.0 3 $1,500,000 $1,050,000 $100,000 $450,000 $180,000.0 $270,000.0 $370,000.0 At the end of the third year the project estimanted salvage value is $200,000. This is an flow for the third year.    Year               Cash flows       1                    $280,000       2                    $316,000       3                    $370,000 + 200,000 = $570,000    Therefor the at 14% cost of capital the NPV calculation is as follows. By using excel spread sheet we can calculate the NPV. Inset NPV in formula bar and take the values as                Rate   = 14%          Value 1   = 280,000          Value 2   = 316,000          Value 3   = 570,000    By enter we can get the value as $783,499.54             NPV      = $783,499.54 - Initial cost. Calculation of initial cost:                   = Cost + Inventory cost                   = $500,000 + ($100,000 - 70,000)                   = $530,000       Therefore  NPV      = $783,499.54 - $530,000                                      = $253,499.54                   = Cost + Inventory cost                   = $500,000 + ($100,000 - 70,000)                   = $530,000       Therefore  NPV      = $783,499.54 - $530,000                                      = $253,499.54 Revenue Operating costs(OC) Depreciation EBIT = Revenue - OC Taxes 40% Net income Cash flows= Dep + Net income 1 $1,000,000 $700,000 $100,000 $300,000 $120,000.0 $180,000.0 $280,000.0 2 $1,200,000 $840,000 $100,000 $360,000 $144,000.0 $216,000.0 $316,000.0 3 $1,500,000 $1,050,000 $100,000 $450,000 $180,000.0 $270,000.0 $370,000.0

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