Question

business finance practice questions

You are financial managers of a company which makes printers. Currently you are using NPV method to evaluate a 10- year project that produces a new model. The WACC is 10% and the tax rate is 21%. (2 points) 1. The project needs a set of machine that is worth $5 million. The company uses 10-year straight-line depreciation, 2. In the past two years, the company spent $800,000 in R&D in developing the new model. 3. The project will be partially financed with debt, and the interest to be paid every year is $100,000. 4. If the new project is taken, it is expected that the current inventory level will increase by $1,500,000, account receivable will increase by $1 million account pavable increases by $800,000, and the minimum cash balance will increase by $0.5 million. 5. The sales from this project will be $8 million per year of which 20 percent will be from lost sales of existing products. 6. The variable costs of the production will be 30% of the sales. 7. The project will require hiring a new manager, who will cost $100,000 per year. In addition, the firm needs to rent a new office for $50,000 a year. 8. Currently, the overhead of the firm is $500,000. And the accounting department will allocate 20% of it to the new project. Please find the NPV of the project. You need to show me the steps to find the initial investment, operation cash flows each year, non-operating cash flows at the end of project lifespan, and NPV. If you do not show the steps, you earn zero.

Answer 1

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10
Sales (8 million x 80% belonging to project)	-7200000	6400000	6400000	6400000	6400000	6400000	6400000	6400000	6400000	6400000	6400000
Variable Cost (30% of sales)	0	1920000	1920000	1920000	1920000	1920000	1920000	1920000	1920000	1920000	1920000
Interest	0	100000	100000	100000	100000	100000	100000	100000	100000	100000	100000
Manager salary	0	100000	100000	100000	100000	100000	100000	100000	100000	100000	100000
Rent	0	50000	50000	50000	50000	50000	50000	50000	50000	50000	50000
OH (allocated 20% of 500000)	0	100000	100000	100000	100000	100000	100000	100000	100000	100000	100000
Depreciation	0	50000	50000	50000	50000	50000	50000	50000	50000	50000	50000
Cash inflow before tax	-7200000	4080000	4080000	4080000	4080000	4080000	4080000	4080000	4080000	4080000	4080000
Tax	0	856800	856800	856800	856800	856800	856800	856800	856800	856800	856800
cash flow after tax + depreciation	-7200000	3273200	3273200	3273200	3273200	3273200	3273200	3273200	3273200	3273200	3273200
Working capital release											2200000
Discount Rate	1	0.909	0.826	0.751	0.683	0.621	0.564	0.513	0.466	0.424	0.385
Present Value	-7200000	2975338.8	2703663.2	2458173.2	2235595.6	2032657.2	1846084.8	1679151.6	1525311.2	1387836.8	2107182
NPV	13750994.4

Initial Investment
Machinery	5 Million
WC	2.2 million
Total	7.2 Million
R&D - Sunk cost therefore not relevant for decision making
Working Capital
Inventory	1.5
Receivables	1
Cash	0.5
Payables	-0.8
Total	2.2
It may be noted that there are 2 schools of thought for including working capital in annual cash flows or including at initial outflow and release at the end of project period