Question

Mustang Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $280,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $115,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 2 percent. Production costs at the end of the first year will be $40,000, in nominal terms, and they are expected to increase at 3 percent per year. The real discount rate is 5 percent. The corporate tax rate is 40 percent.
   
Calculate the NPV of the project.

Answer 1

Answer :- NPV of project is $57,410

Calculation :-

Nominal rate to be used in discounting.

Nominal rate

= (1 + Real rate) x (1 + Inflation rate) - 1
= (1.05 x 1.02) - 1
= 7.10%

NPV = Present value of cash inflow - Cash outflow

= 337410 - 280000

= 57,410

	1	2	3	4	5	6	7
Operating revenue	115,000	117,300	119,646	122,039	124,480	126,970	129,510
(-) Production cost	40,000	41,200	42,436	43,710	45,021	46,371	47,762
Net cash flows	75,000	76,100	77,210	78,329	79,459	80,599	81,748
(-)Depreciation (280000 / 4)	40,000	40,000	40,000	40,000	40,000	40,000	40,000
EBIT	35,000	36,100	37,210	38,329	39,459	40,599	41,748
Taxes@40% (-)	14,000	14,440	14,884	15,331	15,783	16,239	16,699
PAT	21,000	21,660	22,326	22,998	23,676	24,360	25,049
(+) Depreciation	40,000	40,000	40,000	40,000	40,000	40,000	40,000
After-tax cash flows	61,000	61,660	62,326	62,998	63,676	64,360	65,049
discount rate @ 7.1%	0.9338	0.8718	0.8140	0.7600	0.7097	0.6626	0.6187
PV of cash flows	56,962	53,755	50,733	47,878	45,191	42,645	40,246
Total PV of cash inflows							337410