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 $8,000, including a set of eight chairs. The company feels that sales will be 2,450, 2,600, 3,150, 3,000, and 2,750 sets per year for the next five years, respectively. Variable costs will amount to 47 percent of sales and fixed costs are $1.98 million per year. The new dining room table sets will require inventory amounting to 8 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 650 dining room table sets per year of the oak tables the company produces. These tables sell for $5,300 and have variable costs of 42 percent of sales. The inventory for this oak table is also 8 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 $15 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 $15 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 $3.9 million if purchased today, and $6.1 million if purchased in two years. The equipment is depreciated on a seven-year MACRS schedule. The company has a tax rate of 24 percent, and the required return for the project is 13 percent. Refer to Table 8.3.

Calculate the NPV of the new table in Excel.

Answer 1

The equipment must be purchased after 2 years to take benefit of higher salvage value as well as deferment of capital cost

The 7 year MACRS Depreciation rates are 14.29%,24.49%,17.49%,12.49%,8.93%,8.92%,8.93% and 4.46% in years 1-7 respectively

Under these the Free Cash flows are calculated as given below

Year	0	1	2	3	4	5
No of Units		2450	2600	3150	3000	2750
Selling Price		8000	8000	8000	8000	8000
Revenue		19600000	20800000	25200000	24000000	22000000
Less : Variable Cost		9212000	9776000	11844000	11280000	10340000
Less: Fixed Cost		1980000	1980000	1980000	1980000	1980000
Less: Depreciation		0	0	2143500	3673500	2623500
Less: Loss of Existing Sales		1998100	1998100	1998100	0	0
Earnings before Tax		6409900	7045900	7234400	7066500	7056500
Less: Tax@24%		1538376	1691016	1736256	1695960	1693560
Profit After Tax		4871524	5354884	5498144	5370540	5362940
Add : Depreciation		0	0	2143500	3673500	2623500
Net Inventory Costs	1568000	1664000	2016000	1920000	1760000	0
Change In WC	1568000	96000	352000	-96000	-160000	-1760000
Equipment Cost			15000000
Salvage Value						6100000
Free Cashflows	-1568000	4775524	-9997116	7737644	9204040	15846440

NPV = -1568000+4775524/1.13-9997116/1.13^2+7737644/1.13^3+9204040/1.13^4+15846440/1.13^5

=$14,437,317.49