RSM Co is considering a project which will require the purchase of $2.7 million
ID: 2798248 • Letter: R
Question
RSM Co is considering a project which will require the purchase of $2.7 million in new equipment. The equipment will be depreciated straight-line to a book value of $1 million over the 5-year life of the project. Annual sales from this project are estimated at $2,950,000. The variable cost is 40% of the annual sales and there is an annual fixed cost of $200,000. Sway's Back Store will sell the equipment at the end of the project for 30% of its original cost. New net working capital equal to 15% of sales will be required to support the project. All of the new net working capital will be recouped at the end of the project. The firm’s WACC is 12% per year. The tax rate is 40%.
If annual sales is changed to $1,800,000, what is the project’s NPV. assuming every else the same? What is the sensitivity of NPV to annual sales?
Please answer without using Excel. Thank you.
Explanation / Answer
Annual depreciation = (2.7-1)/ 5= 0.34 million
Tax saving on depreciation = 0.136 m
Operating profit before tax = Sales - Costs = 2950000- 40%*2950000 -200000 = 1570000
Operating profit post tax = 1570000*60% = 942000
Sale proceeds of equipment in year 5 = 30%*2700000 = 810,000
Tax saving on Capital loss in year 5= 40%*(810000-1000000) = 76000
Working capital requirement = 15%*2950000 = 442500
The Cash flow table is as below
NPV = 1078000/1.12^1 +1078000/1.12^2+ 1078000/1.12^3+ 1078000/1.12^4+ 2406500/1.12^5 - 3142500
= $1,497,275.32
If annual sales changed to 1800,000, the operating profit post tax will be 528000. Working capital will be 270000
The new cash flow statement will be
NPV will be =
664000/1.12^1 +664000/1.12^2+ 664000/1.12^3+ 664000/1.12^4+ 1820000/1.12^5 - 2970000
= $79516.84
NPV sensitivity = change in NPV/ change in sales
=
= 1.23
Year Initial cost Depreciation tax saving Working capital Operating cash flows post tax Sale of equipment+ tax saving Net Cash flows 0 (2,700,000.00) -442500 (3,142,500.00) 1 136000 942000 1,078,000.00 2 136000 942000 1,078,000.00 3 136000 942000 1,078,000.00 4 136000 942000 1,078,000.00 5 136000 442500 942000 886000 2,406,500.00Related Questions
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