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Net Present Value
Recall the Net Present Value from the previous chapter represents the profit of a project and must be positive for a project or investment to be profitable.
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Example: Calculating NPV
Trans Canada Pipelines is considering a new 4-year project.
- The project requires the purchase of a new machine costing $550,000, installation costs are $100,000.
- The new facility is to be built on a piece of land that the company bought for $200,000 five years ago.
- The current market value of the land is $120,000.
- The research cost associated with the project is $10,000.
- The machine has a useful life of 4 years and a $120,000 salvage value.
- Assets are depreciated using the straight-line method.
- Management believes that sales will increase by $400,000 per year while related costs will increase by $40,000 per year.
- The company will need to increase its Net Working Capital immediately by $10,000 and then increase again to $15,000 in the first year of the project before decreasing it by $2,000 in Year 3 and then to zero in the final year. The cost of capital is calculated in 10% and the marginal tax rate is 40%.
What is the NPV of the project?
Example: Calculating NPV
Trans Canada Pipelines is considering a new 4-year project.
- The project requires the purchase of a new machine costing $550,000; installation costs are $100,000.
- The new facility is to be built on a piece of land that the company bought for $200,000 five years ago.
- The current market value of the land is $120,000. The research cost associated with the project is $10,000.
- The machine has a useful life of 4 years and a $60,000 salvage value.
- Assets are depreciated using a CCA rate of 25%, the half-year rule applies.
- Management believes that sales will increase by $300,000 in the first year and will grow by 7% per year, related expenses are expected to total 25% of revenue.
- Inventory will increase immediately by $15,000 and no additional working capital is required, inventory will no longer be needed at the end of the project.
- The cost of capital is 10% and the marginal tax rate is 40%.
What is the NPV of the project?
Practice
ABC Inc. is considering a new 5-year project.
- The project requires the purchase of a new machine costing $600,000, delivery of the machine is expected to cost $50,000, and the opportunity cost of the project is $30,000.
- The research cost associated with the project is $15,000.
- The machine has a useful life of 5 years and a $75,000 salvage value. Assets are depreciated using the straight-line method.
- Management believes that sales will increase by $300,000 and related expenses are expected to be $80,000 per year.
- Inventory will increase immediately by $15,000 and no additional working capital is required, inventory will no longer be needed at the end of the project.
- The cost of capital is 12% and the marginal tax rate is 30%.
Compute the net present value, round your final answer to the nearest whole dollar.
| The net present value is | $ |
Practice
ABC Inc. is considering a new 5-year project.
- The project requires the purchase of a new machine costing $750,000, delivery of the machine is expected to cost $70,000.
- The machine will be installed on a patch of land owned by the company. The land was purchased 10 years ago for $50,000 and now has a market value of $300,000.
- A soil quality test was performed on the last to make sure the machine could be installed on it.
- The machine has a useful life of 5 years and a 90,000 salvage value.
- The machine is depreciated using a CCA rate of 30%, subject the half-year rule.
- Management believes that sales will increase by $400,000 in year 1 and grow by 10% per year. Related expenses are estimated at 30% of sales.
- Inventory will increase immediately by $25,000 and no additional working capital is required, inventory will no longer be needed at the end of the project.
- The cost of capital is 15% and the marginal tax rate is 40%.
Compute the net present value, round your final answer to the nearest whole dollar.
| The net present value is | $ |