Question

# J. Smythe, Inc., manufactures fine furniture. The company is deciding whether to introduce a new mahogany...

 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.

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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