3. BMT has developed a new product. It can go into production for an initial inv

Question

3. BMT has developed a new product. It can go into production for an initial investment of $4,000,000. The equipment will be depreciated using straight-line depreciation over 4 years to a value of zero. The firm believes that net working capital at each date will equal 25 percent of next year’s forecast sales. The firm estimates that variable costs are equal to 40% of sales and fixed costs are $500,000 per year. Sales forecasts in dollars are below. The project will come to an end after 4 years, when the product becomes obsolete. The firm’s tax rate is 35 percent, and the discount rate is 9 percent. Calculate the NPV.

            Year                0          1                   2                    3                  4  

Sales forecast (in $): 0    2,800,000     3,400,000      3,700,000      4,200,000      

4. In problem 3, perform sensitivity analysis on the following assumptions and find the revised NPV

            (a) sales are 10% lower each year than predicted above

            (b) the discount rate is 12 percent

Explanation / Answer

Discount rate 9% Year 0 1 2 3 4 Initial investment -4000000 Sales 2800000 3400000 3700000 4200000 Fixed cost -500000 -500000 -500000 -500000 Variable cost 1120000 1360000 1480000 1680000 Networking capital -850000 -925000 -1050000 0 Depretiation for tax benefit -1000000 -1000000 -1000000 -1000000 Net CF -4000000 2570000 3335000 3630000 5380000 Tax@35% 0 549500 817250 920500 1533000 Post Tax CF -4000000 2020500 2517750 2709500 3847000 Discounted at 9% -4000000 1853670 2119140 2092231 2725312 NPV 4790352 Sensitivity Analysis Discount rate 12% Year 0 1 2 3 4 Initial investment -4000000 Sales 2520000 3060000 3330000 3780000 Fixed cost -500000 -500000 -500000 -500000 Variable cost 1008000 1224000 1332000 1512000 Networking capital -765000 -832500 -945000 0 Depretiation for tax benefit -1000000 -1000000 -1000000 -1000000 Net CF -4000000 2263000 2951500 3217000 4792000 Tax@35% 0 442050 683025 775950 1327200 Post Tax CF -4000000 1820950 2268475 2441050 3464800 Discounted at 9% -4000000 1625848 1808414 1737491 2201943 NPV 3373697

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