Your mother really dislikes the low quality of T-shirts that your company makes.
ID: 2762094 • Letter: Y
Question
Your mother really dislikes the low quality of T-shirts that your company makes. She also dislikes the low-brow sayings and tasteless pictures that you print on them - she won’t let your younger sister wear them. Thus, your mom has been pestering you to expand and produce a higher quality line of T-shirts in addition to your current selection. Below are the details on this project.
Cost of new equipment: $80,000
Installation cost of equipment: $20,000
Life of equipment: 5 years, Straight line depreciation
Expected sales: $160,000 per year
Expected reduction in sales of cheap T-shirts as your few sober customers will probably shift to the new line: $10,000 per year
Raw material cost: $90,000 per year
New worker salary: $20,000 per year
Required Net working capital over the life of the project: $20,000
Expected Salvage value of equipment at the end of 5 year: $30,000
Tax rate: 35%.
Assuming a WACC of 15%, what is this project’s NPV?
-2,109
4,338
8,870
10,260
12,981
a.-2,109
b.4,338
c.8,870
d.10,260
e.12,981
Explanation / Answer
a. -2109
present value of cash outflow = cost + installation expense + Net working capital required + tax on profit on sale
= $80000 + $20000 + 20000 + [(30000 - 0) * 35%]
= $80000 + $20000 + 20000 + 10500
= $130500
Present value of cash inflow:-
Sales =160000
less: expected reduction in sales = (10000)
less: Expense:
Raw materail (90000)
Workers salary (20000)
Depreciation [(80000+20000 - 30000) / 5years] (14000)
profit before tax 26000
less: tax 35% (9100)
profit after tax 16900
add: depreciation 14000
cash inflow per year $30900
Present value of cash inflow = $30900 * PVAF(15%,5year) + $30000*PVF(15%,5year) + PVF(15%,5year) * 20000
=($30900 * 3.352) + ($30000 *0.497) + ($20000 *0.497)
= 103577 + 14910+ 9940
=128427
NPV = $128427 - $130500
= -$2073 (approx -2109)
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