6 Finance questions about NPV

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Q1: You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ), manufacturers of fine zithers. The market for zithers is growing quickly. The company bought some land three years ago for $1.33 million in anticipation of using it as a toxic waste dump site but has recently hired another company to handle all toxic materials. Based on a recent appraisal, the company believes it could sell the land for $1,430,000 on an aftertax basis. At the end of the project, the land could be sold for $1,530,000 on an aftertax basis. The company also hired a marketing firm to analyze the zither market, at a cost of $118,000. An excerpt of the marketing report is as follows: The zither industry will have a rapid expansion in the next four years. With the brand name recognition that PUTZ brings to bear, we feel that the company will be able to sell 3,100, 4,000, 4,600, and 3,500 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $580 can be charged for each zither. Since zithers appear to be a fad, we feel at the end of the four-year period, sales should be discontinued. PUTZ feels that fixed costs for the project will be $390,000 per year, and variable costs are 20 percent of sales. The equipment necessary for production will cost $2.8 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $365,000. Net working capital of $118,000 will be required immediately and will be recaptured at the end of the project. PUTZ has a 35 percent tax rate and the required return on the project is 12 percent. Refer to Table 8.3. What is the NPV of the project? Q2: 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 people’s homes. They projected unit sales of these lamps to be 8,000 in the first year, with growth of 8 percent each year for the next five years. Production of these lamps will require $45,000 in net working capital to start. The net working capital will be recovered at the end of the project. Total fixed costs are $105,000 per year, variable production costs are $10 per unit, and the units are priced at $38 each. The equipment needed to begin production will cost $185,000. 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 24 percent. What is the NPV of this project? Q3: Sparkling Water, Inc., expects to sell 2.83 million bottles of drinking water each year in perpetuity. This year each bottle will sell for $1.40 in real terms and will cost $.93 in real terms. Sales income and costs occur at year-end. Revenues will rise at a real rate of 6 percent annually, while real costs will rise at a real rate of 5 percent annually. The real discount rate is 10 percent. The corporate tax rate is 38 percent. What is the company worth today? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.) ‫؟‬Value of the firm Q4: Consider the following cash flows on two mutually exclusive projects: Year 0 1 2 3 Project A –$58,000 38,000 33,000 28,000 Project B –$73,000 37,000 46,000 49,000 The cash flows of Project A are expressed in real terms while those of Project B are expressed in nominal terms. The appropriate nominal discount rate is 13 percent and the inflation rate is 5 percent. Calculate the NPV for each project. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) NPV Project A $ Project B $ Q5: Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.91 million. The fixed asset falls into the three-year MACRS class. The project is estimated to generate $2,150,000 in annual sales, with costs of $831,000. The project requires an initial investment in net working capital of $370,000, and the fixed asset will have a market value of $245,000 at the end of the project. If the tax rate is 30 percent, what is the project’s Year 1 net cash flow? Year 2? Year 3? Table 8.3. (Enter your answers in dollars, not millions of dollars. A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 1,234,567.89.) Cash Flow Year 0 $ Year 1 $ Year 2 $ Year 3 $ If the required return is 11 percent, what is the project's NPV? (Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 1,234,567.89.) NPV? Q6: The Freeman Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated below. The corporate tax rate is 34 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project. Investment Sales revenue Operating costs Depreciation Net working capital spending Year 0 $28,000 Year 1 Year 2 Year 3 Year 4 $14,500 3,100 7,000 $15,000 3,200 7,000 $15,500 3,300 7,000 $12,500 2,500 7,000 390 440 340 340 ? a. Compute the incremental net income of the investment for each year. (Do not round intermediate calculations.) Year 1 Net income $ Year 2 Year 3 Year 4 $ $ $ b. Compute the incremental cash flows of the investment for each year. (Do not round intermediate calculations. A negative answer should be indicated by a minus sign.) Cash flow Year 0 Year 1 Year 2 Year 3 Year 4 $ $ $ $ $ c. Suppose the appropriate discount rate is 12 percent. What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV RECOVERY PERIOD CLASS TABLE 8.3 Depreciation under Modified Accelerated Cost Recovery System (MACRS) YEAR 3 YEARS 5 YEARS 7 YEARS 10 YEARS 15 YEARS 20 YEARS 1 2 3 4 5 3333 4445 .1481 .2000 .3200 .1920 .1152 .1152 .0576 .0741 .1429 2449 .1749 .1249 ,0893 0892 .0893 .0446 6 1000 .1800 .1440 .1152 .0922 .0737 .0655 .0655 .0656 .0655 .0328 7 8 .0500 .0950 .0855 .0770 .0693 ,0623 .0590 .0590 .0591 .0590 .0591 .0590 .0591 .0590 .0591 0295 9 10 11 .03750 .07219 .06677 .06177 .05713 .05285 .04888 .04522 .04462 .04461 .04462 .04461 .04462 .04461 .04462 .04461 .04462 .04461 .04462 .04461 .02231 12 13 14 15 16 17 18 19 20 21 Depreciation is expressed as a percent of the asset's cost. These schedules are based on the IRS publication 946. How to Depreciate Property and other details on depreciation are presented later in the chapter. Note that five-year depreciation actually carries over six years because the IRS assumes purchase is made in midyear.
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