Question

J. Smythe, Inc., manufactures fine furniture. The company is deciding whether to introduce a new mahogany dining room table set. The set will sell for $7,500, including a set of eight chairs. The company feels that sales will be 1,950, 2,100, 2,650, 2,500, and 2,250 sets per year for the next five years, respectively. Variable costs will amount to 48 percent of sales, and fixed costs are $1.93 million per year. The new dining room table sets will require inventory amounting to 6 percent of sales, produced and stockpiled in the year prior to sales. It is believed that the addition of the new table will cause a loss of sales of 400 dining room table sets per year of the oak tables the company produces. These tables sell for $4,800 and have variable costs of 43 percent of sales. The inventory for this oak table is also 6 percent of sales. The company believes that sales of the oak table will be discontinued after three years. J. Smythe currently has excess production capacity. If the company buys the necessary equipment today, it will cost $16 million. However, the excess production capacity means the company can produce the new table without buying the new equipment. The company controller has said that the current excess capacity will end in two years with current production. This means that if the company uses the current excess capacity for the new table, it will be forced to spend the $16 million in two years to accommodate the increased sales of its current products. In five years, the new equipment will have a market value of $3.4 million if purchased today, and $6.6 million if purchased in two years. The equipment is depreciated on a seven-year MACRS schedule. The company has a tax rate of 40 percent, and the required return for the project is 10 percent.

Calculate the NPV of the new table. (Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 1,234,567.89.)

Answer 1

year	0	1	2	3	4	5
	$000	$000	$000	$000	$000	$000
sales		14625	15750	19875	18750	16875
variable cost		7020	7560	9540	9000	8100
contribution		7605	8190	10335	9750	8775
fixed cost		1930	1930	1930	1930	1930
before tax cash flow		5675	6260	8405	7820	6845
after tax cash flow ie 60%of cash flow(40%is tax)		3405	3765	5043	4692	4107
loss of sale of oak	(3283.2)
additional working capital at year 3 for machine				(9400)
cash flow	(3283.2)	3405	3765	4357	4692	4107
discount at 10%	1	0.909	0.826	0.751	0.683	0.621
present value	(3283.2)	3092.145	3109.89	(3272.107)	3204.636	2550.447

npv

5404.811

so NPV is positive