Orange Inc., the Cupertino-based computer manufacturer, has developed a new all-

Question

Orange Inc., the Cupertino-based computer manufacturer, has developed a new all-in-one device: phone, music-player, camera, GPS, and computer. The device is called the iPip. The following data have been collected regarding the iPip project. The company has identified a prime piece of real estate and must purchase it immediately for $100,000. In addition, R&D expenditures of $175,000 must be made immediately. During the first year the manufacturing plant will be constructed. The plant will be ready for operation at the end of Year 1. The construction costs are $500,000 and will be paid upon completion. At the end of the Year 1, an inventory of raw materials will be purchased costing $50,000. Production and sales will occur during years 2 and 3. (Assume that all revenues and operating expenses are received (paid) at the end of each year.) Annual revenues are expected to be $850,000. Fixed operating expenses are $100,000 per year and variable operating expenses are 25% of sales. The construction facilities are classified as 10-year property for tax-depreciation purposes. When the plant is closed it will be sold for $200,000. (Note: Assume the investment in plant is depreciated during years 2 and 3.) The land will be sold for $225,000 at the end of year 3. The tax rate on all types of income is 34%. The cost of capital is 12%. What is the NPV for the proposed acquisition if the cost of capital is 12%?

Explanation / Answer

Cash Flow Yr Initial Exp Revenue Operating Exp Depn Salvage Value Revenue before Tax Tax@34% Revenue after Tax Add Depn Net Cash Flow DF @ 12% PV of CF 0         (775,000)         (775,000)       1.0000         (775,000) 1           (50,000)           (50,000)       0.8929           (44,643) 2          850,000    (312,500)         (47,500)          490,000          166,600          323,400          47,500           370,900       0.7972           295,679 3          850,000    (312,500)         (47,500)          490,000          166,600          323,400          47,500           370,900       0.7118           263,999 3          225,000            42,500           182,500       0.7118           129,900 NPV         (130,064) Depreciation = [(175000+500000)-200000]/10 47500 Note in 3rd yr capital gain of $ 225000 - $100000 is taxable @ 34%

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