(NPV/complete venture): What is the NPV for the cash flows in Table 5.1? Use a 35% tax rate, a 15% discount rate, straight-line depreciation, and a 10- year project life. Assume there is no salvage value.

Question

TABLE 5.1
Example 5: Project Cash Flows ($M)

Revenues	Product Costs	Introductory Marketing Expense	One-Time Startup Expense	Working Capital	Capital	Year
—	—	—	—	—	–7	–2
—	—	—	—	—	–25	–1
—	—	—	–2.5	—	–8	0
150	–125	–8	–2.5	–30	—	1
175	–145	–6	—	—	—	2
195	–160	—	—	—	—	3
195	–160	—	—	—	—	4
195	–160	—	—	—	—	5
195	–160	—	—	—	—	6
195	–160	—	—	—	—	7
195	–160	—	—	—	—	8
195	–160	—	—	—	—	9
195	–160	—	—	30	—	10

Accepted Answer

To solve the example, we will complete a table, Table 5.2, similar to the one in Example 1.
We must convert the capital investments in Year–2 and Year–1 into future values (in Year 0) using F/P factors. For Year–2:
F = P(F/P, 15%, 2) = –7(1.323) = –9.3
Working capital must be returned at the end of the project because the economic assumption is that the project is obsolete and would be closed down. When that occurs, the working capital — inventories, accounts payable, and accounts receivable — would be eliminated. Note that working capital is returned at its original value. While other ways exist of handling the return value, this way is simple and conservative.

Next, we will calculate the BT cash flow. This is the sum of the revenues — expenses for a given year. For Year 1:
BT cash flow = (–2.5) + (–8) + (–125) + 150 = 14.5
Now we can calculate depreciation (Equation 2.5) and find the AT cash flow (Equation 2.6) for Year 1:

[latex] ext{Annual deprecation writeoff}= \frac{ ext{Capital investment}}{ ext{Equipment life}}[/latex]

AT Cash flow = (Revenues – Expenses) (1 – Tax rate) + Depreciation write-off = (BT Earnings)(1 – Tax rate) + Depreciation write-off

Annual depreciation write-off = (7 + 25 + 8)/10 = 4
AT cash flow = 14.5 (1 – 0.35) + 4 = 13.4
Depreciation charges begin in Year 1, so for Year 0 the AT cash flow will be:
AT cash flow = 2.5 (1 – 0.35) = –1.6
We then calculate [latex]P_{ ext{AT cash flow}}[/latex] for Year 1:
[latex]P_{ ext{AT cash flow}} = (13.4)(P/F, 15 \%, 1) = (13.4)(0.870) = 11.7[/latex]
The rest of the table is filled out in a similar manner, and [latex]P_{ ext{capital}}[/latex] and [latex]P_{ ext{AT cash flow}}[/latex] are found by summing all the individual Ps for each year. Then:

[latex]NPV = P_{ ext{capital}} + P_{ ext{AT cash flow}} = –64.8 + 115.8 = \$51M[/latex]

TABLE 5.2
Example 5: Cash Flows and NPV ($M)

Year	F/P, 15%, n	P/F, 15%, n	Capital	Working Capital	P, Capital	One-Time Startup Expense	Introductory Marketing Expenses	Product Costs	Revenues	BT cash Flow	AT Cash Flow	P, AT Cash Flow
–2	1.323	—	–7	—	–9.3	—	—	—	—	—	—	—
–1	1.15	—	–25	—	–28.8	—	—	—	—	—	—	—
0	1	1	–8	—	–8.0	–2.5	—	—	—	–2.5	–1.6	–1.6
1	—	0.870	—	–30	–26.1	–2.5	–8	–125	150	14.5	13.4	11.7
2	—	0.756	—	—		—	–6	–145	175	24	19.6	14.8
3	—	0.658	—	—	—	—	—	–160	195	35	26.8	17.6
4	—	0.572	—	—	—	—	—	–160	195	35	26.8	15.3
5	—	0.497	—	—	—	—	—	–160	195	35	26.8	13.3
6	—	0.4323	—	—	—	—	—	–160	195	35	26.8	11.6
7	—	0.3759	—	—	—	—	—	–160	195	35	26.8	10.1
8	—	0.3269	—	—	—	—	—	–160	195	35	26.8	8.8
9	—	0.2843	—	—	—	—	—	–160	195	35	26.8	7.6
10	—	0.2472	—	30	7.4	—	—	–160	195	35	26.8	6.6
				Σ =	–64.8						Σ =	115.8

Question 5.5: (NPV/complete venture): What is the NPV for the cash flows i...

Related Answered Questions

Verified Answer:

Is the ROI of a $22.8M capital project that returns $9.2M per year of gross BT revenues equal to or greater than 15%? Assume a 10-year life and a tax rate of 35%. Because these economic conditions are the same as in Example AT5.1, we will use those guidelines. ...

Verified Answer:

Calculate a rapid ROI estimator based on a hurdle rate of 15%, a project life of 10 years, and a 35% tax rate. ...

Verified Answer:

As part of a new product feasibility, you are studying how much capacity should be built for making and packing a new product. Because a great deal of uncertainty exists about how much volume the new product will generate, you have decided to do a decision tree analysis to help sort out the best ...

Verified Answer:

Perform a sensitivity analysis for capital spending deviations from the expected capital investment for the problem in Example 7 in this chapter. For that project, the most probable estimates are: ...

Verified Answer:

(ROI/complete venture): Find the ROI for the cash flows in Example 5. ...

Verified Answer:

Find the breakeven volume when: • The Product Cost is $12/case at 1000K cases per year • The Product Cost is 75% variable • AT Sales Revenues are $13/case • The tax rate is 35% • The annual depreciation write-off is $600K per year ...

Verified Answer:

(ROI/simple cash flows): Find the ROI for the project described in Example 2. ...

Verified Answer:

Verified Answer:

(AC/single project): What is the AC for Example 2? ...

Verified Answer: