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