1. Drilling-Easy (DE) Inc. currently has two products, low-priced drills and a l
ID: 2794348 • Letter: 1
Question
1. Drilling-Easy (DE) Inc. currently has two products, low-priced drills and a line of smart drill bits. DE Inc. has decided to sell a new line of high-priced drills. Sales for the new line of drills are estimated at $27 million a year. Annual variable costs are 60% of sales. The project is expected to last 5 years. In addition to the production variable costs, the fixed costs each year will be $2,000,000. The company has spent $1,500,000 in a marketing and research study that determined the company will gain $10 million in sales a year of its existing line of smart drill bits. The production variable cost of these sales is $8 million a year. The plant and equipment required for producing the high-priced drills costs $11,000,000 and will be depreciated down to zero over 20 years using straight-line depreciation. It is expected that the plant and equipment can be sold for $4,000,000 at the end of the project. The project will also require an increase in net working capital of $3,000,000 today that will be returned at the end of the project. The tax rate is 30 percent and the require rate of return for this project is 16%. a. What is the initial outlay (IO) for this project? b. What is the operating cash flows (OCF) for each of the years for this project? c. What is the termination value (TV) cash flow (aka recovery cost or after-tax salvage value, or liquidation value of the assets) at the end of the project? d. What is the NPV of this project?Explanation / Answer
a) Initial Outlay = Investment + NWC = 11,000,000 + 3,000,000 = 14,000,000
b) OCF = Net Income + Depreciation
= (Sales - VC - FC + Profits from existing line - Depreciation) x (1 - tax) + Depreciation
Depreciation = Investment / No. of years = 11,000,000 / 20 = 550,000
OCF = (27,000,000 - 60% x 27,000,000 - 2,000,000 + 2,000,000 - 550,000) x (1 - 30%) + 550,000
= 7,725,000
c) Terminal Value cash flow = NWC + After-tax salvage value
Book Value of asset after 5 years = 11,000,000 - 550,000 x 5 = 8,250,000
After-tax Salvage Value = (Salvage Value - Book Value) x (- tax rate) + Salvage Valeu
= (4,000,000 - 8,250,000) x (-30%) + 4,000,000 = $5,275,000
TV = 5,275,000 + 3,000,000 = 8,275,000
d) NPV can be calculated using the same formula in excel or calculator
NPV = NPV(rate = 16%, 7725000...1600000) - 14,000,000 = $15,233,754
DE 0 1 2 3 4 5 Investment -11,000,000 NWC -3,000,000 3,000,000 Salvage 4,000,000 Sales 27,000,000 27,000,000 27,000,000 27,000,000 27,000,000 VC -16,200,000 -16,200,000 -16,200,000 -16,200,000 -16,200,000 Existing Line 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 FC -2,000,000 -2,000,000 -2,000,000 -2,000,000 -2,000,000 Depreciation -550,000 -550,000 -550,000 -550,000 -550,000 EBT 10,250,000 10,250,000 10,250,000 10,250,000 10,250,000 Tax (30%) -3,075,000 -3,075,000 -3,075,000 -3,075,000 -3,075,000 Net Income 7,175,000 7,175,000 7,175,000 7,175,000 7,175,000 Cash Flows -14,000,000 7,725,000 7,725,000 7,725,000 7,725,000 16,000,000 NPV $15,233,754Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.