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| Dickinson Brothers, Inc., is considering investing in a machine to produce computer keyboards. The price of the machine will be $979,000, and its economic life is five years. The machine will be fully depreciated by the straight-line method. The machine will produce 24,000 keyboards each year. The price of each keyboard will be $50 in the first year and will increase by 5 percent per year. The production cost per keyboard will be $15 in the first year and will increase by 5 percent per year. The project will have an annual fixed cost of $199,000 and require an immediate investment of $29,000 in net working capital. The corporate tax rate for the company is 39 percent. The appropriate discount rate is 12 percent. |
| What is the NPV of the investment? |
Solution :
Straight Line Depreciations (5 yr life) per year
= $979,000 / 5 years
=$ 195,800
Now we will calculates sales revenue and production cost each year as follow
| Year | Sales | Production cost | ||
| 1 | 24000*50 | 1,200,000 | 24000*15 | 360,000 |
| 2 | 1,200,000*1.05 | 1260000 | 360,000*1.05 | 378000 |
| 3 | 1,200,000*1.05 | 1323000 | 360,000*1.05 | 396900 |
| 4 | 1,200,000*1.05 | 1389150 | 360,000*1.05 | 416745 |
| 5 | 1,200,000*1.05 | 1458607.5 | 360,000*1.05 | 437582.25 |
Now we will make NPV calculation as follow
| 0 | 1 | 2 | 3 | 4 | 5 | |
| Sales Revenues | 1,200,000 | 1260000 | 1,323,000 | 1,389,150 | 1458607.5 | |
| Production Costs | 360,000 | 378000 | 396900 | 416745 | 437582.25 | |
| Depreciation | 195800 | 195800 | 195800 | 195800 | 195800 | |
| Fixed Cost | 199000 | 199000 | 199000 | 199000 | 199000 | |
| EBIT | 445,200 | 487,200 | 531,300 | 577,605 | 626,225 | |
| Taxes(39%) | 173628 | 190008 | 207207 | 225265.95 | 244227.85 | |
| NOPLATE | 271,572 | 297,192 | 324,093 | 352,339 | 381,997 | |
| Add: depriciation | 195800 | 195800 | 195800 | 195800 | 195800 | |
| CAPEX | -979,000 | |||||
| Change in NWC | -29000 | 0 | 0 | 0 | 0 | 29000 |
| Free Cash Flow | -979,000 | 467,372 | 492,992 | 519,893 | 548,139 | 606,797 |
| PV factor r=12% | 1 | 0.892857 | 0.797194 | 0.711780 | 0.635518 | 0.567427 |
| Prasent Value | -1,008,000 | 417296.4286 | 393010.204 | 370049.568 | 348352.276 | 344313.14 |
| NPV | 865,021.62 |
NPV of the project is $ 865,021.62
