Anderson, Inc. is going into a new line of business-- making back-packs. The com
ID: 2690602 • Letter: A
Question
Anderson, Inc. is going into a new line of business-- making back-packs. The company will need to invest $1,500,000 for the necessary machinery to make back-packs but each back-pack will generate NET cash flow of $40 each during the next 8 years. In other words, we sell 10,000 back packs, the annual operating cash flow will be $400,000. The cost of money (i.e. the discount rate) is 12%. Two questions: a.) What is the NPV of the project? b) At the end of the first year, I think I will be able to sell the business for $1,000,000 if things are not going very well. What volume of back-packs would I need to be selling for it to make sense for me to sell the business?Explanation / Answer
We hace CF0 = -1500,000 Dep pa = Initial Cost/Life = 1500,000/8 = 187500 OCF =EBIT + Depreciation- Taxes = 400,000 for each of 8 Yrs PV of annnuity of $1 for 8 Yrs @12% = 4.9676 So NPV = CF0 + PVA*OCF = -1500,000 + 4.9676*400,000 = $487,040 ...Ans (a) BEP = FC/Net CF = 187500/40 = 4,688 SO If I am selling less than 4,688 backpacks, I wont be able to recover my Fixed costs like Dep. ..............Ans (b)