Your company has been doing well, reaching $1.12 million in earnings, and is con

Question

Your company has been doing well, reaching $1.12 million in earnings, and is considering launching a new product. Designing the new product has already cost 5539, 000. The company estimates that it will sell 780, 000 units per year for $3.01 per unit and variable non-labor costs will be 51.09 per unit. Production will end after year 3. New equipment costing $1.1 million will be required. The equipment will be depreciated to zero using the 7-year MACRS schedule. You plan to sell the equipment for book value at the end of year 3. Your current level of working capital is $295, 000. The new product will require the working capital to increase to a level of $378, 000 immediately, then to $404, 000 in year 1, $355, 000 in year 2, and finally return to $295, 000. Your tax rate is 35%. The discount rate for this project is 10.2%. Do the capital budgeting analysis for this project and calculate its NPV.

Explanation / Answer

Solution:

Before finding the NPV of the project we need to find the cash flows:

The year 0 is negative amount that is the investment or cost incurred

The npv of the project is :

Thank you.

Particulars & formula 0 1 2 3 Initial investment -539000- 1100000 Working capital opening -83000 -109000 -60000 0 Working capital closing 109000 60000 Sale unit 780000 780000 780000 Sales unit price 3.01 3.01 3.01 Total sale( unit price* sale QTY) 2347800 2347800 2347800 Variable cost @1.09 850200 850200 850200 Gross profit 1497600 1497600 1497600 Depreciation staright line 14.29% 157190 157190 157190 EBIT 1340410 1340410 1340410 Tax at 35% 469143.5 469143.5 469143.5 Profit after tax 871266.5 871266.5 871266.5 Salvage value 628430 Cash flow = profit + depreciation+ working+ salvage 1722000 919456.5 1077456.5 1716886.5

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