Question

We project unit sales for a new household-use laser-guided cockroach search and destroy system as follows:

Year
Unit Sales
102,000 114,000
137,000
143,000
96,000
The new system will be priced to sell at $485 each
The cockroach eradicator project will require $1,600.000 in net working capital to start, and total net working capital will rise to 15% of the change in sales. The variable cost per unit is $355, and total fixed costs are $2.700,000 per year. The equipment necessary to begin production will cost a total of $23 million. This equipment is mostly industrial machinery and thus qualifies for CCA at a rate of 20%. In five years, this equipment will actually be worth about 20% of its cost.
The relevant tax rate is 35%, and the required return is 19%. Based on these preliminary estimates, what is the NPV of the project? (Enter the answer in dollars. Do not round your intermediate calculations. Round the final answer to 2 decimal places. Omit 5 sign in your response.)

Answer 1

The NPV of the cockroach eradicator project is calculated by projecting annual cash flows based on sales, costs, depreciation, and taxes, then discounting these cash flows at a 19% required return and subtracting the initial investments.

Step-by-step explanation:

To project the net present value (NPV) of the new cockroach eradicator system, we need to calculate the cash flows for each year and discount them back to present value terms using the required return rate of 19%. The NPV calculation involves revenue, costs, working capital, tax effects, depreciation, and the salvage value of equipment.

First, we calculate the annual revenue by multiplying the unit sales by the price per unit. Then we subtract both variable and fixed costs to determine earnings before interest and taxes (EBIT). Working capital requirements are 15% of the change in sales each year. We calculate depreciation using the capital cost allowance (CCA) rate of 20% on the equipment's initial cost. Taxes are then calculated at 35% of EBIT minus depreciation.

At the end of five years, the equipment will be sold for 20% of its initial cost, which must also be incorporated into the NPV calculation by adding the after-tax salvage value to the cash flow of Year 5. Finally, each year's cash flow is discounted to present value using the required return of 19%, and the NPV is the sum of these present values. The initial $23 million cost for equipment and $1.6 million in net working capital are subtracted from the sum of discounted cash flows to determine the final NPV.