Question

Aria Acoustics, Inc. (AAl), projects unit sales for a new seven-octave voice emulation implant as follows: Year Unit Sales 1 - 71,000 2 - 84,000 3 - 103,000 4 - 95,000 5 - 64,000 Production of the implants will require $2,300,000 in net working capital to start and additional net working capital investments each year equal to 15 percent of the projected sales increase for the following year. Total fixed costs are $2,900,000 per year, variable production costs are $285 per unit, and the units are priced at $410 each. The equipment needed to begin production has an installed cost of $14,800,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS property. In five years, this equipment can be sold for about 20 percent of its acquisition cost. The tax rate is 21 percent and the required return is 18 percent. What is the NPV of the project? What is the IRR?

Answer 1

The NPV (Net Present Value) of a project is the difference between the present value of cash inflows and the present value of cash outflows over a specific period of time. It measures the profitability of an investment by taking into account the time value of money.

To calculate the NPV of the project, we need to determine the cash inflows and outflows for each year and discount them to their present value. The cash inflows are the revenues generated from the unit sales, while the cash outflows include the production costs, fixed costs, working capital investments, and the initial equipment cost.

To calculate the cash inflows, we multiply the unit sales by the selling price per unit. To calculate the cash outflows, we sum up the fixed costs, variable production costs, working capital investments, and the initial equipment cost. We also need to consider the salvage value of the equipment after five years.

The IRR (Internal Rate of Return) is the discount rate that makes the NPV of a project equal to zero. It is the rate of return the project is expected to generate.

To calculate the IRR, we can use trial and error or financial software. We adjust the discount rate until the NPV equals zero. In this case, you would need to provide the specific values for the fixed costs, variable production costs, selling price per unit, working capital investments, initial equipment cost, salvage value, and the projected unit sales for each year. With those values, we can calculate the NPV and IRR of the project.

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