Sanders Enterprises, Inc., has been considering the purchase of a new manufactur

Question

Sanders Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $278,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $113,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 5 percent. Production costs at the end of the first year will be $38,000, in nominal terms, and they are expected to increase at 6 percent per year. The real discount rate is 8 percent. The corporate tax rate is 35 percent. Sanders has other ongoing profitable operations.

Calculate the NPV of the project.

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Sanders Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $278,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $113,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 5 percent. Production costs at the end of the first year will be $38,000, in nominal terms, and they are expected to increase at 6 percent per year. The real discount rate is 8 percent. The corporate tax rate is 35 percent. Sanders has other ongoing profitable operations.

Explanation / Answer

Year Investment Annual Income net of tax saving on Deprecition net of tax Production cost net of tax Net Cash Flow ROR @ 8% PV 0               (278,000)                               -                                             -               (278,000)                        1         (278,000) 1                             -                       73,450                                  13,900                    (24,700)                  62,650               0.926              58,014 2                             -                       77,123                                  13,900                    (26,182)                  64,841               0.857              55,568 3                             -                       80,979                                  13,900                    (27,753)                  67,126               0.794              53,298 4                             -                       85,028                                  13,900                    (29,418)                  69,509               0.735              51,089 5                             -                       89,279                                  13,900                    (31,183)                  71,996               0.681              49,029 6                             -                       93,743                                  13,900                    (33,054)                  74,589               0.630              46,991 7                             -                       98,430                                  13,900                    (35,037)                  77,293               0.583              45,062 NPV              81,051

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