Top Inc. is interested in developing a new toy.The toys will sell for $25 each a
ID: 2647754 • Letter: T
Question
Top Inc. is interested in developing a new toy.The toys will sell for $25 each and they plan to sell 10 million toys at the end of each year for 4 years.Variable costs are $20 per toy; fixed costs are $10,000,000 per year.The interest expense is $3,000,000 per year.The project requires an additional machine that costs $120,000,000 to be depreciated to a zero book value on a straight?line basis over 4 years.The machine has a salvage value of $20,000,000. The tax rate is 40%.The initial investment in net working capital is $5,000,000.No additional net working capital is needed for the project and no net working capital will be returned.The variable and fixed costs do not include the depreciation and the interest expenses.There is no horizon value.
A: If the cost of capital is 8%, find the net present value. = 0.03
B: Find the internal rate of return.
This part B. was confusing please clear up on how to do!
C: Do you accept the project? Explain.
NPV is positive so project is accepted
Particulars
NPV is positive so project is accepted
Calculation of cash flow after tax:Particulars
Amount ($ in million) Contribution 50 (10 toys * 5 ) less: fixed cost 10 less: intrest expense 3 less: depreciation ((120 - 20))/4=25 25 earning before tax (contribution - fixed cost - intrest exp. - depreciation) 12 less: tax @ 40% (earning before tax *40%) 4.8 earning after tax (earning before tax - tax) 7.2 add : depreciation 25 Cash flow after tax ( earning after tax + depreciation) 32.2 Calculation of cash outflow: Particulars Amount ($ in million) Original cost of machine (A) 120 Investment in net working capital (B) 5 Total (A+B) 125 Calculation of NPV: Particulars Time P.V. Factor (8%) Amount ($ in million) P.V. ($ in million) CAsh outflow 0 1 125 125.00 P.V of cash outflow (A) 125.00 Cash Inflow: cash inflow after tax (B) 1-4 3.31 32.2 106.65 terminal value (C) 4 0.74 20 14.70 Release of net working capital (D) 4 0.74 5 3.68 P.V. of cash inflow (B+C+D) 125.03 N.P.V (P.V. of cash inflow -P.V. of cash Outflow) 0.03 contribution = sales - variable cost contribution =25-20=5$ Depreciation = (original cost - salvage valoue ) / useful life Depreciation = (120 - 20) / 4 = 25Explanation / Answer
A: If the cost of capital is 8%, find the net present value.
B: Find the internal rate of return.
IRR = irr({-125,34.20,34.20,34.20,46.20})
IRR = 7%
C: Do you accept the project?
No the project would not be accepted since NPV is negative
Particulars Amount ($ in million) Contribution 50 (10 toys * 5 ) less: fixed cost 10 less: intrest expense 3 less: depreciation 120/4 30 earning before tax (contribution - fixed cost - intrest exp. - depreciation) 7 less: tax @ 40% (earning before tax *40%) 2.8 earning after tax (earning before tax - tax) 4.2 add : depreciation 30 Cash flow after tax ( earning after tax + depreciation) 34.2 Calculation of cash outflow: Amount ($ in million) Particulars Original cost of machine (A) 120 Investment in net working capital (B) 5 Total (A+B) 125 Calculation of NPV: Time P.V. Factor (8%) Amount ($ in million) P.V. ($ in million) Particulars CAsh outflow 0 1 125 125 P.V of cash outflow (A) 125 Cash Inflow: 1 0.9259 34.2 31.67 2 0.8573 34.2 29.32 3 0.7938 34.2 27.15 4 0.7350 46.2 33.96 P.V. of cash inflow 122.10 N.P.V (P.V. of cash inflow -P.V. of cash Outflow) 2.90 contribution = sales - variable cost contribution =25-20=5$ Note: Deprecition is written to Zero Book value Depreciation = (original cost - salvage valoue ) / useful life Depreciation = (120 - 0) / 4 = 30 Post tax Salvage Value = 20*(1-40%) = $ 12 Million Working Capital Realised = $ 0 Million Year 4 Cash Flow = Operating Cash Flow + Post Tax salvage Value + Working Capital realised Year 4 cash flow = 34.2 + 12 + 0 Year 4 cash flow = 46.20