Question

Bate Company manufactures fishing poles and is considering expanding into the artificial bait business. The life of the project is 6 years and the WACC for Bate Company is 12%. The new manufacturing equipment required for artificial bait manufacturing will cost $180,000 and the new manufacturing equipment will be depreciated at $30,000 per year. Bate will sell 50,000 units of artificial bate at a price of $2 per unit for all 6 years of the project and variable costs will be $1 per unit sold. Fixed costs will be $10,000 per year and Bate Company paid a consultant $20,000 in order to evaluate the viability of the project. The project will require an investment of $15,000 in NOWC which the company will receive at the end of the project. If Bate Company’s tax rate is 30%, should the firm undertake the new project of manufacturing artificial bait? Use the NPV criteria to make your decision

Answer 1

Annual Operating cashflows:
Sales revenue (50000*2)			100000
Less: Variable cost (50000*1)			50000
Less: Fixed cost			10000
Less: Depreciation			30000
Net income before tax			10000
Less: Tax @ 30%			3000
After tax income			7000
Add: Depreciation			30000
After tax Cashflows			37000
Annual Operating cashflows				37000
Multiply: Annuity PVF at 12% fr 6yrs				4.11141
Present value of inflows					152122.2
Add: Present value of WC release (15000*0.506631)					7599.465
Total Inflows					159721.6
lEss: Initial Investment					180000
Less: Working capital investment					15000
Net Present value					-35278.4
The Project shall not be accepted