Gillette had developed a new razor. The company was evaluating introducing the n

Question

Gillette had developed a new razor. The company was evaluating introducing the new product and had developed the following projections. Starting from year 6, Revenue, COGS, Op. Expenses will be the same as year 5, and go on forever. The project involves a $10,000,000 investment for a machine (in year 0) that is depreciated on a straight-line basis for 4 years (year 1 to year 4) to a salvage value of zero. The production will require a $2,000,000 initial (year 0) investment in net working capital. Only half of the working capital will be recovered in year 4. Calculate the NPV of the Gillette New Razor Project with a 15% OCC and 35% tax rate. (5 points) Year 0 1 2 3 4 5 6+ Revenue $10,000,000 $15,000,000 $20,000,000 $21,000,000 $22,050,000 same as yr 5 COGS $5,000,000 $7,500,000 $10,000,000 $10,500,000 $11,025,000 same as yr 5 Op. Expenses $2,000,000 $2,500,000 $3,000,000 $3,150,000 $3,307,500 same as yr 5

Explanation / Answer

1) Calculation of NPV of Gillette new product :

Initial cash outlay:

             Cost of machine = $10,000,000

   Add:   Working capital = $2,000,000

          Total out lay      = $12,000,000

Annual depreciation :

             Depreciation = $2,500,000    ($10,000,000/4years)

Calculation of net annual cash inflows :

Calculation of NPV :

       Calculation of Terminal cash flow :

                          Year 6 = 6th year cashflow / discount rate or rate of return

                                     = 5016375 / 0.15

                                     = $33,442,500

        Year 6 discounted cash flow = 33,442,500 * 0.497

                                                  = $16,620,923

      NPV = - Initial cash flow + Net annual cash flows + Year 6 Discounted cash flow

              = - 12,000,000 + 14,952,868 + 16,620,923

              = $19,573,791

Particulars Y1 Y2 Y3 Y4 Y5 Y6 Revenue 10,000,000 15,000,000 20,000,000 21,000,000 22,050,000 22,050,000 Cost of goods sold (5,000,000) (7,500,000) (10,000,000) (10,500,000) (11,025,000) (11,025,000) Operating expenses (2,000,000) (2,500,000) (3,000,000) (3,150,000) (3,307,500) (3,307,500) Gross margin 3,000,000 4,000,000 7,000,000 7,350,000 7,717,500 7,717,500 Depreciation (2,500,000) (2,500,000) (2,500,000) (2,500,000) nil nil Profit before tax 500,000 1,500,000 4,500,000 4,850,000 7,717,500 7,717,500 Tax@35% (175,000) (525,000) (1,575,000) (1,697,500) (2,701,125) (2,701,125) Profit after tax 325,000 975,000 2,925,000 3,152,500 5,016,375 5,016,375 Depreciation 2,500,000 2,500,000 2,500,000 2,500,000 nil nil Net cash inflow 2,825,000 3,475,000 5,425,000 5,652,500 5,016,375 5,016,375

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