With the growing popularity of casual surf print clothing, two recent

QUESTION

With the growing popularity of casual surf print clothing, two recent
MBA graduates decided to broaden this casual surf concept to encompass a surf lifestyle
for the home. With limited capital, they decided to focus on surf print table and floor lamps
to accent peoples homes. They projected unit sales of these lamps to be 5,000 in the first year,
with growth of 15 percent each year for the next five years. Production of these lamps will
require $28,000 in net working capital to start. Total fixed costs are $75,000 per year, variable
production costs are $20 per unit, and the units are priced at $45 each. The equipment needed
to begin production will cost $60,000. The equipment will be depreciated using the straight-line
method over a five-year life and is not expected to have a salvage value. The effective tax rate is
34 percent, and the required rate of return is 25 percent. What is the NPV of this project?
Solution: Year Sales units WC & Equipment cost FC VC Sales Tax saving on depreciation Net Cash flow Discount Factor @ 25% Discounted Amount 0 (88,000) (88,000) 1 (88,000) 1 5,000 (75,000) (100,000) 225,000 4,080 54,080 0.800 43,264 2 5,750 (75,000) (115,000) 258,750 4,080 72,830 0.640 46,611 3 6,613 (75,000) (132,250) 297,563 4,080 94,393 0.512 48,329 4¦

7,604 (75,000) (152,088) 342,197 4,080 119,189 0.410 48,820 5 8,745 (75,000) (174,901) 393,526 4,080 147,706 0.328 48,400 NPV 147,424 Calculation of depreciation = Cost less Salvage value / Life Depreciation= 60,000/5 Depreciation = 12,000

ANSWER:

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