Question

Mary’s Apparel Company is considering manufacturing a new style of pants. The equipment to be used costs $99,000 and would be depreciated to zero by the straight-line method over its 3-year life. It would have a zero salvage value, and no new working capital would be required. Annual revenues are $65,000 and annual operating costs are $25,000. Revenues and operating costs are expected to be constant over the project’s 3-year life. However, this project would compete with other existing products and would reduce their pre-tax annual cash flows of $5,000. The project’s WACC is 10% and corporate tax rate is 35%. What is the project’s NPV?

Answer 1

Annual revenue 65000

less : operating cost. -25000

less: decrease in annual cash flow -5000

less : Depreciation(99000/3). -33000

___________________________________________

Profit before tax 2000

less: tax @ 35%. -700

___________________________________________

Profit after tax. 1300

Add: Depreciation. 33000

___________________________________________

Annual free cash flow (F) = 34300

___________________________________________

Time (n) = 3 years Wacc (i)= 10%

Present value of annual cash inflows = F*(1-(1/(1+i)^n)/i

34300*(1-(1/(1+10%)^3))/10%

85299.02329

Initial Investment = 99000

NPV = Present value of Cash inflows - initial investment

85299.02329 -99000

-13700.97671

NPV is -$13700.98. So Project should not be accepted.

Please thumbs up