Aria Acoustics, Inc. (AAI), projects unit sales for a new seven-octave voice emu

Question

Aria Acoustics, Inc. (AAI), projects unit sales for a new seven-octave voice emulation implant as follows: Production of the implants will require S1,610,000 in net working capital to start and additional net working capital investments each year equal to 10 percent of the projected sales increase for the following year. Total fixed costs are $1,510,000 per year, variable production costs are S270 per unit, and the units are priced at S385 each. The equipment needed to begin production has an installed cost of $21,100,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS property. In five years, this equipment can be sold for about 15 percent of its acquisition cost. AAI is in the 30 percent marginal tax bracket and has a required return on all its projects of 17 percent. MACRS schedule What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) What is the IRR? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Explanation / Answer

CALCULATION OF NPV & IRR

_________________________________________________________________________________________

YEAR                                                1                           2                         3                         4                     5           

1. Sales (units)                              82,000                   95,000              109,000               104,000           85,000       

2 .Sales Revenue (1 x $385)    31,570,000           36,575,000         41,965,000         40,040,000    32,725,000   

3. Variable cost (1 x $270)        22,140,000           25,650,000         29,430,000          28,080000      22,950,000   

4. Total Fixed costs                   1,510,000             1,510,000           1,510,000           1,510,000        1,510,000    

5. Depreciation                          3,015,190              5,167,790           3,690,390           2,635,390        1,884,230    

6.Pre tax profit (2-3-4-5)            4,904,810              4,247,210           7,334,610           7,814,610        6,380,770  

7. Tax @ 30%                            1,471,443             1,274,163           2,200,383           2,344,383        1,914,231  

8.Profit after tax                         3,433,367              2,973,047          5,134,227           5,470,227         4,466,539  

9.Cash Flows (8+5)                  6,448,557              8,140,837          8,824,617           8,105,617         6,350,769  

CALCULATION OF NET CASH FLOWS:

_____________________________________________________________________________________________

YEAR                                    1                           2                            3                               4                      5                      

Operating Cash flows      6,448,557             8,140,837               8,824,617                 8,105,617         6,350,769         

Change in NWC             -3,657,500          - 5,390,000               1,925,000                  7,315,000         1,417,500

   

Capital spending                 --                         --                              --                                --                   3,627,603      

Total net Cash flows        2,783,057            2,750,837             10,749,617                15,420,617        11,395,872     

CALCULATION OF PROJECT CASH OUTFLOW I.E INITIAL INVESTMENT

CAPITAL INVESTMENT                  $ 21,100,000

Working capital required                       1,610,000

Total Capital required                         22,710,000

CALCULATION OF NPV:

NPV = (-) $22,710,000 + 2,783,057/(1+0.17) +2,750,837/(1+0.17)2+10,749,617/(1+0.17)3+15,420,617/(1+0.17)4+11,395,872

NPV =$ (-) 22,710,000 + 2,378,681.20 + 2,009,523.71 + 6,711,744.35 +8,229,213.01 + 5,197,803.36 = $1,816,965.63

IRR = NPV = 0; SO FOR IRR CALCULATION,WE TAKE EXPECTED RETURN AS 30% AND FIND NPV TO INTERPOLATE IRR:

NPV = (-) 22,710,000 + 2,783,057/(1+30) + 2,750,837/(1+0.30)2 + 10,749,617/(1+0.30)3 +15,420,617/(1+0.30)4+11,395,872/(1+0.30)5

= (-)22,710,000 + 2,140,813.08 +1,627,714.20+4,892,861.63+5,399,186.65+3,069,239.66 = (-) 5,580,184.78    

CALCULATION OF IRR :     

PRESENT VALUE REUIRED           = 22,710,000  

TOTAL PRESENT VALUE @17%    = 24,526,965.63

TOTAL PRESENT VALUE @30%    = 17,129,815.22

IRR = LOWER RATE + (PRESENT VALUE @17% - PRESENT VALUE REQUIRED)/(TOTAL PRESENT VALUE @17% - TOTAL PRESENT VLAUE @30%) X DIFFERENCE IN RATE

IRR = 17% + (1,816,965.63/7,397,150.41) X 13 = 17% + 3.19% = 20.19%

ANSWERS :

NPV = $1,816,965.63

IRR = 20.19%

COMMENT: Since NPV Is positive and IRR ie. 20.19% is greater than required rate of return ie. 17%, project will be accepted

WORKING NOTES: To calculate after tax salvage value, we first calculate ending book value ie. purchase pirce less total deprecaition for five years :

Ending Book value = 21,100,000 - (3,015,190+5,167,790+3,690,390+2,635,390+1,884,230) =

NOTE: Recovery of working capital in year 5 = -3,657,500 +(-5,390,000)+1,925,000+7,315,000 +(-1,610,000)=$4,707,010

The market value of used equipment is 15% of purchase pricce i.e 3,165,000, hence, after tax salvage value will be

=3,165,000+(4,707,010 - 3,165,000) x (0.30) = $3,627,603

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.