Appendix A Solutions to Self-Test Questions and Problems A-15c. Year^0 Year^1 Year^2 Year^3
Equipment purchase ($65,000)
Change in NWC (2,000)
Revenues (4,000 × $50) $200,000 $200,000 $200,000
Variable costs (70%) 140,000 140,000 140,000
Fixed costs 30,000 30,000 30,000
Depreciation 21,450 29,250 9,750
EBIT $ 8,550 $ 750 $ 20,250
Taxes (40%) 3,420 300 8,100
AT operating income $ 5,130 $ 450 $ 12,150
Add back: Depreciation 21,450 29,250 9,750
Salvage value 10,000
Tax on salvage value (2,180)
Recovery of NWC 2,000
Project cash flows ($67,000) $ 26,580 $ 29,700 $ 31,720
!67,000 26,580 29,700 31,720
(^0) 11% 1 2 3
d. From the time line shown in Part c, the project’s NPV can be calculated as
follows:
NPV! "$67,000 # $26,580/(1.11)^1 # $29,700/(1.11)^2 # $31,720/(1.11)^3
! $4,245
Alternatively, using a! nancial calculator, you would enter CF 0! "67000,
CF 1! 26580, CF 2! 29700, CF 3! 31720, and I/YR! 11 and then solve for
NPV! $4,245.
Since the NPV is positive, the project should be accepted.
e. Project analysis if unit sales turned out to be 20% below forecast:
Initial projection! 4,000 units; however, if unit sales turn out to be only 80%
of forecast, unit sales! 3,200.
Year 0 Year 1 Year 2 Year 3
Equipment purchase ($65,000)
Change in NWC (2,000)
Revenues (3,200 $ $50) $160,000 $160,000 $160,000
Variable costs (70%) 112,000 112,000 112,000
Fixed costs 30,000 30,000 30,000
Depreciation 21,450 29,250 9,750
EBIT ($ 3,450) ($ 11,250) $ 8,250
Taxes (40%) (1,380) (4,500) 3,300
AT operating income ($ 2,070) ($ 6,750) $ 4,950
Add back: Depreciation 21,450 29,250 9,750
Salvage value 10,000
Tax on salvage value (2,180)
Recovery of NWC 2,000
Project cash flows ($67,000) $ 19,380 $ 22,500 $ 24,520
!67,000 19,380 22,500 24,520
(^0) 11% 1 2 3
NPV Calculation: