Consider the following project of Hand Clapper, Inc. The company is considering
ID: 2748777 • Letter: C
Question
Consider the following project of Hand Clapper, Inc. The company is considering a four-year project to manufacture clap-command garage door openers. This project requires an initial investment of $16.3 million that will be depreciated straight-line to zero over the project’s life. An initial investment in net working capital of $1,030,000 is required to support spare parts inventory; this cost is fully recoverable whenever the project ends. The company believes it can generate $13.5 million in pretax revenues with $5.4 million in total pretax operating costs. The tax rate is 38 percent and the discount rate is 13 percent. The market value of the equipment over the life of the project is as follows:
Year Market Value (millions)
1 $14.30
2 11.30
3 8.80
4 2.15
(Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
a. Assuming the company operates this project for four years, what is the NPV?
b. Compute the project NPV assuming the project is abandoned after one year.
c. Compute the project NPV assuming the project is abandoned after two years.
d. Compute the project NPV assuming the project is abandoned after three years.
Explanation / Answer
a. NPV of the company operates the project for four years:-
Year Cash flow PVAF(13% ,4years) PVAF(13% ,4years) Present Value
0 -16300000 1 -16300000
0 -1030000 1 -1030000
1-4 5022000 2.974 14935428
4 1030000 - 0.613 631390
NPV = present value of cash inflow - present value of cash outflow
= (14935428+ 631390) - (16300000 + 1030000)
= 15566818 - 17330000
=-$1763182
Note:- net cash inflow:
pre tax revenue = 13500000
less: operating cost = 5400000
pre tax income = 8100000
less: Tax @38% = 3078000
Net cash inflow = 5022000