Vandelay Industries is evaluating a project that costs $1,350,000 and has a 20 y
ID: 2715055 • Letter: V
Question
Vandelay Industries is evaluating a project that costs $1,350,000 and has a 20 year life. Depreciation will be straight-line to zero over the life of the project. Management believes they will be able to sell the equipment at the end of the project for $50,000. Sales are projected to be 50,000 units in the first year, 70,000 units in the second year, and 25,000 units for all additional years. Price per unit is $34.50, variable cost per unit is $15.50 and fixed costs are $300,000 per year. The project also requires an initial investment in net working capital of $150,000 and for the project to maintain a net working capital balance equal to $150,000 plus 15% of sales while the project is ongoing. All net working capital will be recouped at the end of the project. This project will have an additional spillover effect that will impact existing sales negatively. The net pre-tax impact of the spillover effect will be -$75,000 per year. This project will also have a positive spillover effect. Specifically, the project will generate additional sales of 100 units of an existing product at a price of $15 each. The existing product has variable costs of $9 and fixed costs of $5,000 per year. The company’s marginal tax rate is 35%. The required return on similar projects is 11%.
What is the project’s NPV?
What is the project’s payback period?
What is the project’s profitability index?
What is the project’s IRR?
Why might this company decide to pursue this project?
Explanation / Answer
Year Sale Contribution Fixed Cost Income Depreciation Net Income EAT Cashflows Initial Cash Capital Solvage Negative Possitive Cashflow at 11% Value Amount year Value at 10.0433% 0 -1500000 -1500000 1 -1500000.00 -1500000.00 1 50000 950000 300000 650000 67500 582500 378625 446125 -7500 -48750 600 390475 0.900901 351779.28 390475.00 1 354837.60 2 70000 1330000 300000 1030000 67500 962500 625625 693125 -3500 -48750 600 641475 0.811622 520635.50 641475.00 1 529727.51 3 25000 475000 300000 175000 67500 107500 69875 137375 7250 -48750 600 96475 0.731191 70541.69 96475.00 1 72397.57 4 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.658731 58775.27 89225.00 1 60846.01 5 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.593451 52950.69 89225.00 1 55292.79 6 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.534641 47703.33 89225.00 1 50246.40 7 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.481658 42975.97 89225.00 1 45660.57 8 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.433926 38717.09 14675.00 0.164472 41493.27 9 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.390925 34880.26 37706.32 10 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.352184 31423.66 34264.98 11 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.317283 28309.60 31137.73 12 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.285841 25504.15 28295.89 13 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.257514 22976.71 25713.41 14 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.231995 20699.74 23366.63 15 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.209004 18648.41 21234.03 16 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.188292 16800.37 19296.07 17 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.169633 15135.47 17534.98 18 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.152822 13635.56 15934.62 19 25000 475000 300000 175000 67500 107500 69875 137375 -48750 600 89225 0.137678 12284.29 14480.32 20 25000 475000 300000 175000 67500 107500 69875 137375 50000 -48750 600 139225 0.124034 17268.62 20532.66 Total -58354.33 1500000.00 7.16 -0.66 Project NPV -58354 Payback period 7 IRR is 10.04% as at this rate Net Present value is zero Present Value of Initial Cash 1500000 Present Value of Cash inflows 1441646 Profitability Index 0.96 Company may pursue this project because of its payback period is only 7 year and having possitive IRR of 10.04% Note: Sales per unit 34.5 Less: Variable cost 15.5 Contribution per unit 19 Annual Depreciation = 1,350,000/20 = 37,500 Initial Investment: Project cost 1350000 Initial Working capital 150000 Total 1500000
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