With the growing popularity of casual surf print clothing, two recent MBA gradua

Question

With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital, they decided to focus on surf print table and floor lamps to accent people’s homes. They projected unit sales of these lamps to be 7,500 in the first year, with growth of 7 percent each year for the next five years. Production of these lamps will require $40,000 in net working capital to start. The net working capital will be recovered at the end of the project. Total fixed costs are $100,000 per year, variable production costs are $20 per unit, and the units are priced at $48 each. The equipment needed to begin production will cost $180,000. The equipment will be depreciated using the straight-line method over a five-year life and is not expected to have a salvage value. The effective tax rate is 35 percent and the required rate of return is 24 percent. What is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
  
NPV

Explanation / Answer

Here we have a project in which the quantity sold each year increases.

First, we need to calculate the quantity sold each year by increasing the current year’s quantity by the growth rate.

So, the quantity soldeach year will be:

Year 1 quantity = 7500

Year 2 quantity = 7500(1 + .07) = 8025

Year 3 quantity = 8025(1 + .07) = 8586

Year 4 quantity = 8586(1 + .07) = 9187

Year 5 quantity = 9187(1 + .07) = 9830

Now we can calculate the sales revenue and variable costs each year. The pro forma income statementsand operating cash flow each year will be:

So NPV = -220000 + 84100/1.24 + 93655/1.24^2 + 103865.2/1.24^3 + 114804.7/1.24^4 + 166506/1.24^5

= -220000 + 67822.58 + 60909.85 + 54475.97 + 48559.35 + 56796.48

= $ 68,564.23

year0 Year1 year 2 Year 3 Year 4 year 5 Revenue (no of units * 48) 360,000 385200 412128 440976 471840 Fixed Costs 100000 100000 100000 100000 100000 Variable costs (no of units * 20) 150000 160500 171720 183740 196600 Depreciation (=180000/5) 36000 36000 36000 36000 36000 EBT = revenue - fixed cost - variable cost - depreciation 74000 88700 104408 121238 139240 Taxes = .35 * EBT 25900 31045 36542.8 42433.3 48734 Net Income = EBT - taxes 48100 57655 67865.2 78804.7 90506 OCF = net income + depreciation 84100 93655 103865.2 114804.7 126506 Capital Spending -180000 NWC -40000 40000 Total cash flow -220000 84100 93655 103865.2 114804.7 166506

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