You are considering adding a new item to your company’s line of products. The ma

Question

You are considering adding a new item to your company’s line of products.  The machine required to manufacture the item costs $400,000 and it falls into the three-year MACRS classification.  The MACRS three-year depreciation rates are 33%, 45%, 15%, and 7%.  The new item would require a $40,000 increase in inventory and a $30,000 increase in accounts payable.  You plan to market the items for three years and then sell the machine for $70,000.  You expect to sell 20,000 items per year at a price of $10 in the first year. You expect manufacturing costs to be $4 per item.  If the tax rate is 40% and your weighted average cost of capital is 12% per year, what is the net present value of selling the new item?  What should you do?

Explanation / Answer

Since NPV is negative so reject the project.

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A B C D Year 0 1 2 3 1 Investment on machine -400000 2 Increase in inventory -40000 3 Increase in accounts payable 30000 4 Sales=20,000*10 200000 200000 200000 5 Manufacturing Costs 80000 80000 80000 6 Macrs Rate 33% 45% 15% 7 Depreciation = Machine Cost* Depreciation Rate 132000 180000 60000 8 EBT=Sales-Cost-Depreciation -12000 -60000 60000 9 Taxes=EBT * TAX Rate -4800 -24000 24000 10 EAT= EBT - Taxes -7200 -36000 36000 11 ADD Depreciation 132000 180000 60000 12 ADD After TAX Salvage Value 42000 13 Free Casah Flow -410000 124800 144000 138000 14 WACC 12% NPV -85549.84 Using Excel formula = NPV(A14,B13:D13)+A13

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