Your company has been doing well, reaching $1.06 million in annual earnings, and

Question

Your company has been doing well, reaching $1.06 million in annual earnings, and is considering launching a new product. Designing the new product has already cost $533,000. The company estimates that it will sell 829,000 units per year for $3.04 per unit and variable non-labor cost will be $1.05. Production will end after year 3. New equipment costing $1.17 million will be required. The equipment will be depreciated 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 $308,000. The new product will require the working capital to increase to a level of $375,000 immediately, then to $390,000 in year 1, $356,000 in year 2, and finally return to $308,000. Your tax rate is 35%. The discount rate for this project is 10.3%. Do the capital budgeting analysis for this project and calculate its NPV.

Explanation / Answer

829000 units 1170000 Initial Cost 0 -67000 NWC TAX 35% 3.04 per unit sales price 7years MACRS 1 -15000 Discount rate 10.30% 1.05 VC Non labor Depreciation Book Value 2 34000 1.99 Contribution 1 14.29% $        1,170,000 $            167,193 $      1,002,807 3 48000 $        1,649,710 Sales per year 2 24.49% $        1,170,000 $            286,533 $         716,274 3 17.49% $        1,170,000 $            204,633 $         511,641 4 12.49% $        1,170,000 $            146,133 $         365,508 NPV Analysis 5 8.93% $        1,170,000 $            104,481 $         261,027 Year Cash Flow PVF @ 10.3% Present Value 6 8.92% $        1,170,000 $            104,364 $         156,663 0 -1170000 1 -1170000 7 8.93% $        1,170,000 $            104,481 $            52,182 0 -67000 1 -67000 8 4.46% $        1,170,000 $              52,182 $                     -   1 1115829 0.906618314 1011631.006 2 1206598 0.821956767 991771.3908 Year 1 2 3 3 1703574 0.745201058 1269505.147 Sales 1649710 1649710 1649710 NPV $ 2,035,907.54 Depreciation 167193 286533 204633 Income 1482517 1363177 1445077 Tax @ 35% 518880.95 477111.95 505776.95 OCF 1130829 1172598 1143933 NwC-OCF -15000 34000 48000 Salvage Value-OCF 511641 $        1,115,829 $        1,206,598 $        1,703,574

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