Question 3a: Calculate the NPV of the project

Solve by Net Present Value method

Working Year 0 Year 1 Year 2 Year 3 Year 4
Activities
Cost of equipment (2,000,000)
Net working capital changes [beginning] e (400,000)

Sales 10 % increament per year a - 3,000,000 3,300,000 3,630,000 3,993,000

Variable cost = 40% of sales b (1,200,000) (1,320,000) (1,452,000) (1,597,200)

Fixed cost (500,000) (500,000) (500,000) (500,000)
Depreciation = 2m / 4years c (500,000) (500,000) (500,000) (500,000)
Profit before tax 800,000 980,000 1,178,000 1,395,800
Tax on profit at 30 % d (240,000) (294,000) (353,400) (418,740)
Net Profit after tax 560,000 686,000 824,600 977,060
Net working capital recovered f 200,000
Residual value of equipmemnt g 300,000
Net Cash flow (2,400,000) 560,000 686,000 824,600 1,477,060
Discount factor at 10 % h 1.000 0.8547 0.7305 0.6243 0.5336
Discounted Cash flow (2,400,000) 478,632 501,123 514,798 788,159

Net present value [add all cash flow] (117,288) negative

Decision
The company should not take on the project because it has a positive net present value.
It would rather invest its $2,000,000 and receive interest at 17 % per annum
This will give 2,000,000[1.17]^4 = 3,747,774 -2,000,000 = 1,747,774 profit over 4 years

Calculations;
a. Sales = 2,000,0000 [yr 1], yr2 = sales x 1.1, yr 3 = sales x 1.1 x 1.1 etc
b. variable costs = 0.40 of sales
c. Depreciation = 2m / 4 years = 500,000
d. Tax on profit = profit before tax x 0.30 per each year
e. NWC beginning = 2m x 0.20 = 400,000
f. NWC recovered I year 5 = 400,000 x 0.50 = 200,000

negative = Cash outflow

positive = Cash inflow