RSM Co is considering a project which will require the purchase of $2.7 million
ID: 2798250 • 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%.
In the worst case, annual sales decreases to $1.2 million, and WACC increases to 15%. What is the project’s NPV under the worst case?
Please answer without using Excel. Thank you.
Explanation / Answer
Computation of NPV under the worst case:
Year
0
1
2
3
4
5
Sales
1,200,000
1,200,000
1,200,000
1,200,000
1,200,000
Less: variable cost (1,200,000*40%)
(480,000)
(480,000)
(480,000)
(480,000)
(480,000)
Less: Fixed costs
(200,000)
(200,000)
(200,000)
(200,000)
(200,000)
Less: Depreciation (2,700,000-1,000,000/5years)
(340,000)
(340,000)
(340,000)
(340,000)
(340,000)
Add: salvage value of equipment (2,700,000*30%)
810,000
Add: recovery of net working capital (1,200,000*15%)
180,000
Earnings before tax
180,000
180,000
180,000
180,000
1,170,000
Less: tax at 40%
(72,000)
(72,000)
(72,000)
(72,000)
(468,000)
Earnings after tax
108,000
108,000
108,000
108,000
702,000
Add: Depreciation
448,000
448,000
448,000
448,000
1,042,000
Cash flows
(2,880,000)
556,000
556,000
556,000
556,000
1,744,000
Discounting factor at 15%
1.00000
0.86957
0.75614
0.65752
0.57175
0.49718
PV of cash flows
(2,880,000)
483,478.26
420,415.88
365,579.03
317,894.80
867,076.23
NPV
(425,555.80)
Year
0
1
2
3
4
5
Sales
1,200,000
1,200,000
1,200,000
1,200,000
1,200,000
Less: variable cost (1,200,000*40%)
(480,000)
(480,000)
(480,000)
(480,000)
(480,000)
Less: Fixed costs
(200,000)
(200,000)
(200,000)
(200,000)
(200,000)
Less: Depreciation (2,700,000-1,000,000/5years)
(340,000)
(340,000)
(340,000)
(340,000)
(340,000)
Add: salvage value of equipment (2,700,000*30%)
810,000
Add: recovery of net working capital (1,200,000*15%)
180,000
Earnings before tax
180,000
180,000
180,000
180,000
1,170,000
Less: tax at 40%
(72,000)
(72,000)
(72,000)
(72,000)
(468,000)
Earnings after tax
108,000
108,000
108,000
108,000
702,000
Add: Depreciation
448,000
448,000
448,000
448,000
1,042,000
Cash flows
(2,880,000)
556,000
556,000
556,000
556,000
1,744,000
Discounting factor at 15%
1.00000
0.86957
0.75614
0.65752
0.57175
0.49718
PV of cash flows
(2,880,000)
483,478.26
420,415.88
365,579.03
317,894.80
867,076.23
NPV
(425,555.80)
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.