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**

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