Question

Medavoy Company is considering a new project that complements its existing business. The machine required for the project costs $4.85 million. The marketing department predicts that sales related to the project will be $2.68 million per year for the next four years, after which the market will cease to exist. The machine will be depreciated to zero over its 4-year economic life using the straight-line method. Cost of goods sold and operating expenses related to the project are predicted to be 25 percent of sales. The company also needs to add net working capital of $225,000 immediately. The additional net working capital will be recovered in full at the end of the project's life. The corporate tax rate is 25 percent and the required return for the project is 12 percent. What is the value of the NPV for this project? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.

Answer 1

The value of the NPV for this project is $1,419,671.

Step-by-step explanation:

To calculate the Net Present Value (NPV) for this project, we need to consider the initial investment, projected cash flows, discount rate, and project duration.

Initial investment: $4.85 million

Projected annual sales: $2.68 million for four years

Depreciation period: four years

Cost of goods sold and operating expenses: 25% of sales

Net working capital: $225,000

Corporate tax rate: 25%

Required return: 12%

Step 1: Calculate the annual cash flows:

Year 1: $2.68 million

Year 2: $2.68 million

Year 3: $2.68 million

Year 4: $2.68 million

Step 2: Calculate the depreciation expense:

The machine will be depreciated to zero over its 4-year economic life using the straight-line method. Therefore, the annual depreciation expense is $4.85 million / 4 = $1.21 million.

Step 3: Calculate the annual operating expenses:

The cost of goods sold and operating expenses are predicted to be 25% of sales. Therefore, the annual operating expenses are 25% * projected sales.

Year 1: 25% * $2.68 million = $0.67 million

Year 2: 25% * $2.68 million = $0.67 million

Year 3: 25% * $2.68 million = $0.67 million

Year 4: 25% * $2.68 million = $0.67 million

Step 4: Calculate the annual cash flows after tax:

The corporate tax rate is 25%. Therefore, the annual cash flows after tax are the projected sales minus the operating expenses and taxes.

Year 1: $2.68 million - $0.67 million - ($2.68 million - $0.67 million) * 25% = $1.68 million

Year 2: $2.68 million - $0.67 million - ($2.68 million - $0.67 million) * 25% = $1.68 million

Year 3: $2.68 million - $0.67 million - ($2.68 million - $0.67 million) * 25% = $1.68 million

Year 4: $2.68 million - $0.67 million - ($2.68 million - $0.67 million) * 25% = $1.68 million

Step 5: Calculate the net working capital:

The net working capital of $225,000 is added immediately and recovered in full at the end of the project's life.

The NPV is calculated by discounting the annual cash flows and net working capital to their present value using the required return of 12%.

NPV = (Cash Flow Year 1 / (1 + Discount Rate)^1) + (Cash Flow Year 2 / (1 + Discount Rate)^2) + ... + (Cash Flow Year n / (1 + Discount Rate)^n) - Initial Investment

NPV = ($1.68 million / (1 + 0.12)^1) + ($1.68 million / (1 + 0.12)^2) + ($1.68 million / (1 + 0.12)^3) + ($1.68 million / (1 + 0.12)^4) + ($225,000 / (1 + 0.12)^4) - $4.85 million

Calculating the NPV:

NPV = $1,500,000 + $1,339,286 + $1,194,215 + $1,066,487 + $169,683 - $4,850,000

= $1,419,671