Question

Please add the explanation.

4. Your company may introduce a new line of tennis shoes. You have been given the following projections: sales = 35,000 units @ $40 per unit; variable costs = $25 per unit; fixed costs = $125,000 per year; initial investment = $1,000,000; interest expense = $50,000 per year; project life = 10 years. What is the net income for this project if the corporate tax rate is 34%? You may assume straight-line depreciation and a discount rate of 12%.

A) $119,000

B) $165,000

C) $198,000

D) $264,000

E) $297,000

Answer 1

We calculate the per year costs and revenue of this project. The fixed costs are 125000 per year and adding the interest expense we have 175000 per year. The profit we get per unit from selling is 40 - 25 = $15 per unit. Since a sale of 35000 units is expected, it becomes a total of 35000 x 15 = 525000.

Hence, the per year profit = 525000 - 175000 = 350000. After-tax profit becomes = 350000 x (1-0.34) = 231,000. So, now we solve the NPV of this situation when we are 1 million initially and getting 231,000 in each year.

NPV = -1000000 + 231000/1.12 + 231000/1.12^2 + .... + 231000/1.12^10 = $298,000. Option E.