Question

# Your company has been doing well, reaching \$1.09 million in earnings, and is considering launching a...

Your company has been doing well, reaching \$1.09 million in earnings, and is considering launching a new product. Designing the new product has already cost \$539,000. The company estimates that it will sell 812,000 units per year for \$3.05 per unit and variable non-labor costs will be \$1.16 per unit. Production will end after year 3. New equipment costing \$1.05 million will be required. The equipment will be depreciated using 100% bonus depreciation under the 2017 TCJA. You think the equipment will be obsolete at the end of year 3 and plan to scrap it. Your current level of working capital is \$303,000. The new product will require the working capital to increase to a level of \$375,000 immediately, then to \$404,000 in year 1, in year 2 the level will be \$342,000, and finally in year 3 the level will return to \$303,000. Your tax rate is 21%. The discount rate for this project is 9.5%.

Do the capital budgeting analysis for this project and calculate its NPV. Note: Assume that the equipment is put into use in year 1.

The free cashflows for the firm are calculated as shown below :

 Year 0 1 2 3 No of Units 812000 812000 812000 Selling Price per unit 3.05 3.05 3.05 Variable Cost per unit 1.16 1.16 1.16 Revenue 2476600 2476600 2476600 Less: Variable Cost 941920 941920 941920 Profit Before Tax 1534680 1534680 1534680 Less: Tax @21% 322282.8 322282.8 322282.8 Profit after Tax 1212397.2 1212397.2 1212397.2 Capital Cost (net of Depreciation) 829500 Working capital 375000 404000 342000 303000 Change in Working capital 72000 29000 -62000 -39000 Free Cash flows -901500 1183397.20 1274397.20 1251397.20

NPV = - 901500+1183397.20/1.095+1274397.20/1.095^2+1251397.20/1.095^3

= \$2,195,220.77

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