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Emperor's Clothes Fashions can invest $5 million in a new plant for producing invisible makeup. What is NPV? What is NPV if variable costs turn out to be $1.20 per jar? What is NPV if fixed costs turn out to be $1.5 million per year?

Emperor's Clothes Fashions can invest $5 million in a new plant for producing invisible makeup. The plant has an expected life of 15 years, and expected sales are 6 million jars of makeup a year. Fixed costs are $2 million a year, and variable costs are $1 per jar. The product will be priced at $2 per jar. The plant will be depreciated straight-line over 5 years to salvage value of zero. The opportunity cost of capital is 10%, and the tax rate is 40%.
(a) What is the project's NPV under these base-case assumptions?
(b) What is NPV if variable costs turn out to be $1.20 per jar?
(c) What is NPV if fixed costs turn out to be $1.5 million per year?
(d) At what price per jar would the project's NPV equal zero?

Note the answers should be:
a) 5.6 million
b) 2.9 million
c) 6.8 million
d) $1.59 per jar

Solution Preview

Actually the plant life is 5 years as its depreciated in 5 years to nil. Thus the project life is 5 years.

a. What is project NPV under these base-case assumptions?
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Revenue $12,000,000 $12,000,000 $12,000,000 $12,000,000 $12,000,000
Less Expense $8,000,000 $8,000,000 $8,000,000 $8,000,000 $8,000,000
Less Depreciation $1,000,000 $1,000,000 $1,000,000 $1,000,000 $1,000,000
Profit before Tax $3,000,000 $3,000,000 $3,000,000 $3,000,000 $3,000,000
Less Taxes $1,200,000 $1,200,000 $1,200,000 $1,200,000 $1,200,000
Profit after Tax $1,800,000 $1,800,000 $1,800,000 $1,800,000 $1,800,000
Add Depreciation $1,000,000 $1,000,000 $1,000,000 $1,000,000 $1,000,000

Cash flow $2,800,000 $2,800,000 $2,800,000 $2,800,000 $2,800,000
Capital Outlay -5000000
Net Cash flows -5000000 $2,800,000 $2,800,000 $2,800,000 $2,800,000 $2,800,000

Cost of capital 10%
NPV $5,614,202.95 or 5.6 mn

NPV is positive and ...

Solution Summary

Computations done for you in Excel (attached). No references.

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