Question

We are evaluating a project that costs 1,710,000, has a 6-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 86,400 units per year. The price per unit is $38.01, the variable cost per unit is $23.25, and fixed costs are $818,000 per year. The tax rate is 21 percent, and we require a return of 9 percent on this project. What is the net present value (NPV) of the project?

Answer 1

To answer the student's question, the net present value (NPV) for the project is calculated by projecting annual cash flows based on sales, costs, depreciation, taxes, and then discounting these cash flows at the required 9% return rate minus the initial project cost.

Step-by-step explanation:

The student is asking for the calculation of the net present value (NPV) of a project with specific financial details. To calculate the NPV, we initially estimate the project's cash flows, which involve revenue, costs, depreciation, and taxes, and then discount them using the required rate of return. Given that the sales are projected at 86,400 units per year at a price of $38.01 per unit, the gross revenue would be $3,281,664 annually. Subtracting the variable cost of $23.25 per unit results in a total variable cost of $2,009,200, leaving a contribution margin of $1,272,464.

Adding in the annual fixed cost of $818,000 and then considering the depreciation expense, which is the project cost of $1,710,000 spread evenly over 6 years (i.e., $285,000 per year), we arrive at a taxable income. By applying the tax rate of 21%, we can calculate the annual net income. The NPV is then found by discounting these net cash flows over the project life at the required 9% rate of return and subtracting the initial project cost. It is important to note that the calculation requires several steps and precise attention to the cash flow each year.