Question

Emperor’s Clothes Fashions can invest $8 million in a new plant for producing invisible makeup. The plant has an expected life of 5 years, and expected sales are 9 million jars of makeup a year. Fixed costs are $2.9 million a year, and variable costs are $2.10 per jar. The product will be priced at $3.10 per jar. The plant will be depreciated straight-line over 5 years to a salvage value of zero. The opportunity cost of capital is 10%, and the tax rate is 30%.

a. What is project NPV under these base-case assumptions?

b. What is NPV if variable costs turn out to be $2.40 per jar?

c. What is NPV if fixed costs turn out to be $2.2 million per year?

d. At what price per jar would project NPV equal zero?

Answer 1

Emperor	0	1	2	3	4	5
Investment	-8,000,000
Sales		27,900,000	27,900,000	27,900,000	27,900,000	27,900,000
VC		-18,900,000	-18,900,000	-18,900,000	-18,900,000	-18,900,000
FC		-2,900,000	-2,900,000	-2,900,000	-2,900,000	-2,900,000
Depreciation		-1,600,000	-1,600,000	-1,600,000	-1,600,000	-1,600,000
EBT		4,500,000	4,500,000	4,500,000	4,500,000	4,500,000
Tax (30%)		-1,350,000	-1,350,000	-1,350,000	-1,350,000	-1,350,000
Net Income		3,150,000	3,150,000	3,150,000	3,150,000	3,150,000
Cash Flows	-8,000,000	4,750,000	4,750,000	4,750,000	4,750,000	4,750,000
NPV	$10,006,237.15

Cash Flows = Investment + Net Income + Depreciation

NPV can be calculated using the same function in excel or calculator using 10% discount rate.

If VC = 2.4 per jar, then NPV = $2,841,650.16

If FC = 2.2m, then NPV = $11,863,722.67