Question
We believe we can sell 90,000 home security devices per year at $150 a piece. They cost $130 to manufacture (variable cost). Fixed production costs
We believe we can sell 90,000 home security devices per
year at $150 a piece. They cost $130 to manufacture
(variable cost). Fixed production costs run $215,000 per year.
The necessary equipment costs $ 785,000 to buy and would
be depreciated at a 25 percent CCA rate. The equipment
would have a zero salvage value after the five-year life of the
project. We need to invest $140,000 in net working capital
upfront; no additional net working capital investment is
necessary. The discount rate is 19 percent, and the tax rate is
35 percent. What do you think of the proposal?
current solution:
16.Initial investment: $785,000 (equipment cost) + $140,000 (net working capital) = $925,000
OCF = (Sales Costs)(1 T); T = 0.35
Sales = 90,000 x $150 = $13,500,000
Costs = 90,000 x $130 = $11,700,000 + $215,000 (fixed costs) = $11,915,000
OCF = ($13,500,000 - $11,915,000)(1 0.35) = $1,030,250
Year
0
1
2
3
4
5
OCF
1030250
1030250
1030250
1030250
1030250
NWC
-140000
0
0
0
0
0
Capital Spending
-785000
0
0
0
0
0
Total Project Cash Flow
-925000
1030250
1030250
1030250
1030250
1030250
Discount rate
19%
NPV
$2,225,128.35
Based on the NPV being positive, the asset should be accepted. (excludes salvage value, depreciation, and tax shield)
Year
Beginning UCC
CCA rate
CCA
Ending UCC
1
$392,500.00
25%
$98,125.00
$294,375.00
2
$686,875.00
25%
$171,718.75
$515,156.25
3
$515,156.25
25%
$128,789.06
$386,367.19
4
$386,367.19
25%
$96,591.80
$289,775.39
5
$289,775.39
25%
$72,443.85
$217,331.54
Based on the above table, the equipment will have a UCC of $217,331.54 at the end of the project.
Salvage value after the project: $0
PV (CCA tax shield) = (925000 x 0.19 x 0.35)/(0.25 + 0.19) x (1 + 0.5(0.19))/(1 + 0.19)
*Second half of the formula is irrelevant since the salvage value is 0
PV (CCA tax shield) = 139,801.14 x 0.92 = $128,617.05 add this to the earlier NPV calculation
NPV = $2,225,128.35 + $128,617.05 = $2,353,745.40 accept project
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