Sanders Enterprises, Inc., has been considering the purchase of a new manufactur
ID: 2825283 • Letter: S
Question
Sanders Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $288,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $123,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 4 percent. Production costs at the end of the first year will be $48,000, in nominal terms, and they are expected to increase at 5 percent per year. The real discount rate is 7 percent. The corporate tax rate is 40 percent.
Sanders Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $288,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $123,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 4 percent. Production costs at the end of the first year will be $48,000, in nominal terms, and they are expected to increase at 5 percent per year. The real discount rate is 7 percent. The corporate tax rate is 40 percent.
Explanation / Answer
Depreciation of equipment = (Initial cost –Salvage value)/Useful life
= $ 288,000/7 = $ 41,142.86
Computations of annual revenue and expenses:
Year
1
2
3
4
5
6
7
Annual revenue
$123,000
$123,000 x 1.04
$127,920
x1.04
$133,036.80
x 1.04
$138,358.27
x1.04
$143,892.60
x 1.04
$149,648.31
x 1.04
=$127,920
=$133,036.80
=$138,358.27
=$143,892.60
=$149,648.31
=$155,634.24
Annual expenses
$48,000
$48,000
x 1.05
$50,400
x 1.05
$52,920
x 1.05
$55,566
x 1.05
$58,344.30
x 1.05
$61,261.52
x 1.05
=$50,400
=$52,920
=$55,566.00
=$58,344.30
=$61,261.52
=$64,324.59
Computations of annual cash flow:
Year
1
2
3
4
5
6
7
Revenue
$123,000.00
$127,920.00
$133,036.80
$138,358.27
$143,892.60
$149,648.31
$155,634.24
Less: Production cost
$48,000.00
$50,400.00
$52,920.00
$55,566.00
$58,344.30
$61,261.52
$64,324.59
Less: Depreciation
$41,142.86
$41,142.86
$41,142.86
$41,142.86
$41,142.86
$41,142.86
$41,142.86
EBIT
$33,857.14
$36,377.14
$38,973.94
$41,649.41
$44,405.45
$47,243.93
$50,166.79
Less: Tax @ 40%
$13,542.86
$14,550.86
$15,589.58
$16,659.77
$17,762.18
$18,897.57
$20,066.72
Net income
$20,314.29
$21,826.29
$23,384.37
$24,989.65
$26,643.27
$28,346.36
$30,100.07
Add: Depreciation
$41,142.86
$41,142.86
$41,142.86
$41,142.86
$41,142.86
$41,142.86
$41,142.86
Cash Flow
$61,457.14
$62,969.14
$64,527.22
$66,132.51
$67,786.12
$69,489.22
$71,242.93
Computation of NPV:
Year
Cash Flow (C)
PV Factor calculation
PV Factor @ 7 % (F)
PV (= C x F)
0
($288,000)
1/(1+7%)^0
1
($288,000.00)
1
$61,457.14
1/(1+7%)^1
0.934579439
$57,436.58
2
$62,969.14
1/(1+7%)^2
0.873438728
$54,999.69
3
$64,527.22
1/(1+7%)^3
0.816297877
$52,673.44
4
$66,133.51
1/(1+7%)^4
0.762895212
$50,452.17
5
$67,786.12
1/(1+7%)^5
0.712986179
$48,330.57
6
$69,489.22
1/(1+7%)^6
0.666342224
$46,303.60
7
$71,243.93
1/(1+7%)^7
0.622749742
$44,366.52
NPV
$66,562.56
Year
1
2
3
4
5
6
7
Annual revenue
$123,000
$123,000 x 1.04
$127,920
x1.04
$133,036.80
x 1.04
$138,358.27
x1.04
$143,892.60
x 1.04
$149,648.31
x 1.04
=$127,920
=$133,036.80
=$138,358.27
=$143,892.60
=$149,648.31
=$155,634.24
Annual expenses
$48,000
$48,000
x 1.05
$50,400
x 1.05
$52,920
x 1.05
$55,566
x 1.05
$58,344.30
x 1.05
$61,261.52
x 1.05
=$50,400
=$52,920
=$55,566.00
=$58,344.30
=$61,261.52
=$64,324.59
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