What is the projects initial outlay?
Should the project be accepted why or why not?
New Caledonia Problem
35% tax bracket
12% discount rate
Cost of new plant $9,000,000.00
Shipping and $350,000.00
Sales:
Year Sales
1 125,000 units
2 140,000 units
3 190,000 units
4 150,000 units
5 100,000 units
Sales price per unit - $550 each year’s 1-4 and $450 year 5
Variable cost per unit - $210
Annual fixed costs - $235,000
To determine the initial outlay of the project, we need to add up all the costs incurred at the beginning of the project. In this case, the costs are the cost of the new plant and the shipping cost.
The initial outlay = cost of new plant + shipping cost
= $9,000,000 + $350,000
= $9,350,000
Now let's analyze whether the project should be accepted or not. To make this decision, we need to calculate the net present value (NPV) of the project. The NPV measures the profitability of the project by taking into account the cash flows over time and the discount rate.
To calculate the NPV, we need to calculate the cash inflows and outflows for each year and discount them to their present value. The cash inflows are the sales revenue minus the variable cost, minus the fixed costs. The cash outflow is the initial outlay.
Year 1:
Sales revenue = 125,000 units x $550 = $68,750,000
Variable cost = 125,000 units x $210 = $26,250,000
Cash inflow = $68,750,000 - $26,250,000 - $235,000 = $42,265,000
Discounted cash inflow = $42,265,000 / (1 + 12%)^1 = $37,696,246.41
Similarly, we can calculate the discounted cash inflow for each year and then sum them up.
Year 2:
Sales revenue = 140,000 units x $550 = $77,000,000
Variable cost = 140,000 units x $210 = $29,400,000
Cash inflow = $77,000,000 - $29,400,000 - $235,000 = $47,365,000
Discounted cash inflow = $47,365,000 / (1 + 12%)^2 = $37,993,488.14
Year 3:
Sales revenue = 190,000 units x $550 = $104,500,000
Variable cost = 190,000 units x $210 = $39,900,000
Cash inflow = $104,500,000 - $39,900,000 - $235,000 = $64,365,000
Discounted cash inflow = $64,365,000 / (1 + 12%)^3 = $45,448,996.39
Year 4:
Sales revenue = 150,000 units x $550 = $82,500,000
Variable cost = 150,000 units x $210 = $31,500,000
Cash inflow = $82,500,000 - $31,500,000 - $235,000 = $50,765,000
Discounted cash inflow = $50,765,000 / (1 + 12%)^4 = $31,026,987.49
Year 5:
Sales revenue = 100,000 units x $450 = $45,000,000
Variable cost = 100,000 units x $210 = $21,000,000
Cash inflow = $45,000,000 - $21,000,000 - $235,000 = $23,765,000
Discounted cash inflow = $23,765,000 / (1 + 12%)^5 = $12,246,061.46
Now, we can calculate the NPV by summing up the discounted cash inflows and subtracting the initial outlay:
NPV = Sum of discounted cash inflows - Initial outlay
= $37,696,246.41 + $37,993,488.14 + $45,448,996.39 + $31,026,987.49 + $12,246,061.46 - $9,350,000
= $155,061,779.89
Since the NPV is positive, $155,061,779.89, the project should be accepted. Having a positive NPV indicates that the project is expected to generate more cash inflow than the initial investment, providing a return greater than the discount rate.