Question

Terry Simpson is considering investing in screen printing equipment and opening a retail business that specializes in customized T-shirts. The screen-printing equipment will cost $12,000 to purchase and set up. It is expected to have a useful life of six years and will need to be overhauled in year 4 at a cost of about $4,000. At the end of six years, it is expected to be worthless. T-shirts will sell for $19 each and the average cost of buying the T-shirts and printing them is expected to be $12 each. Terry estimates that customers will buy 50 T-shirts per day, 24 days per month for 12 months. Furthermore, monthly operating costs excluding Terry’s salary are expected to total $5,000 per month. In order to do the work necessary to make this business succeed, Terry would have to leave a job that pays $36,000 per year.

What is the expected annual sales?

What is the expected annual net cash inflow from operations including Terry’s salary and excluding equipment purchase and overhaul?

What is the net present value of the screen-printing equipment if Terry must earn a 15% return on the investment in the equipment?

Answer 1

Expected Annual Sales in Units = 50*24*12 = 14400

Expected Annual Sales in $ = 14400*$19 = $273600

Expected annual net cash inflow from operations including Terry’s salary and excluding equipment purchase and overhaul = Expected annual Sales - Per Year Equipment Purchase Cost - Annual Operating Costs

= 273600 - 12000/6 - 5000*12

= 273600 - 2000 - 60000 = $211600

These remain same for all the years except Year 4 when overhauled cost is there. Year 4 Net Cash Inflow = 211600 - 4000 = 207600

Net present value of the screen-printing equipment = Cost + Present Value of 4000 at present

= 12000 + 4000/[(1+.15)^3]

= 12000 + 2630

= $14630

Assuming Overhauled cost was incurred at year 4 beginning.