2. Matrix Printers, Inc. is considering entering the laser printing business. An

Question

2. Matrix Printers, Inc. is considering entering the laser printing business. An entirely new plant will be needed which will cost $1,500,000. Land for the plant will cost an additional $250,000. Both of these costs will be incurred immediately. The plant will be depreciated straight line over its 15 year life. (Remember the rule about depreciating land.) In addition to these costs an investment of $100,000 will be needed for working capital. The plant will generate sales of $300,000 per year and have associated expenses of $175,000. The firms marginal tax rate is 34%. The plant will be sold in 15 years for $700,000. What is the NPV of making this investment if the required rate of return is 16%. Should they make the investment?

Explanation / Answer

Investment = 1,500,000 + 250,000 = 1,750,000 and NWC = 100,000 => Total Investment = 1,850,000

Depreciation = 1,500,000 / 10 = 150,000

Annual Cash Flow = Net Income + Depreciation = (Sales - Costs - Depreciation) x (1 - tax) + Depreciation

= (300,000 - 175,000 - 150,000) x (1 - 34%) + 150,000

= 133,500

In the last year, firm would get an additional cash flow = After-tax salvage value + NWC = 700,000 x (1 - 0.34) + 100,000 = 562,000

On a financial calculator, let's calculate the present value of future cash flows

N = 15, PMT = 133,500, FV = 562,000, I/Y = 16% => Compute PV = $804,978.38

NPV = PV - Investment = 804,978 - 1,850,000 = - $1,045,022

As the NPV < 0, they should not make the investment.

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