question archive Weston Clothing Company is considering manufacturing a new style of shirt, whose data are shown below
Weston Clothing Company is considering manufacturing a new style of shirt, whose data are shown below
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Weston Clothing Company is considering manufacturing a new style of shirt, whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. However, this project would compete with other Weston's products and would reduce their pre-tax annual cash flows. What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.)
Cost of capital 10.0%
Pre-tax cash flow reduction for other products (cannibalization) $5,000
Investment cost (depreciable basis) $80,000
Straight-line deprec. rate 33.333%
Sales revenues, each year for 3 years $67,500
Annual operating costs (excl. deprec.) $25,000
Tax rate 25.0%
a. $6,196
b. $6,522
c. $6,848
d. $7,190
e. $7,550
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| Initial cost | = | $80,000 | ||
| Depreciation | = | Total cost/Useful life | ||
| = | $80,000/3 | |||
| = | $26,666.67 | |||
| Computation of Cashflows and Present Value of Cash Flows: | ||||
| a) | Sales | = | $67,500 | |
| b) | Operating cost | = | $25,000 | |
| c) | Reduction in pretax Cas Flows | = | $5,000 | |
| d) | Depreciation | = | $26,666.67 | |
| e) | Profit(a-b-c-d) | = | $10,833.33 | |
| f) | Tax(e*25%) | = | $2,708.33 | |
| g) | Net profit(e-f) | = | $8,125.00 | |
| h) | Cashflow(g+d) | = | $34,791.67 | |
| i) | PVAF(10%,3 years) | = | $2.49 | |
| j) | PV of cash inflow(h*i) | = | $ 86,522 | |
| NPV | = | Cash Inflow-Cash Outlow Initially | ||
| = | $86,522-$80,000 | |||
| = | $ 6,522.00 | |||
So, the correct option is B "$6,522".
