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Investment Analysis for New Project

The company is considering investing in a new water purification system project that would sell 25,000 systems per year. The total investment costs are $2.5 million with fixed annual costs of $325,000 and variable costs of 40% of sales. The cash flows were calculated over the 5 year project period. The NPV of the project is $965,091.12 and the IRR is 24.25%, both of which are above the required return of 12%. Therefore, the company should invest in the project.

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Farzan Yahya Habib
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143 views2 pages

Investment Analysis for New Project

The company is considering investing in a new water purification system project that would sell 25,000 systems per year. The total investment costs are $2.5 million with fixed annual costs of $325,000 and variable costs of 40% of sales. The cash flows were calculated over the 5 year project period. The NPV of the project is $965,091.12 and the IRR is 24.25%, both of which are above the required return of 12%. Therefore, the company should invest in the project.

Uploaded by

Farzan Yahya Habib
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as XLSX, PDF, TXT or read online on Scribd

Home Assignment 02

Question 02

A company is considering an investment into a new project. The company is going to sell a new
purification system. They are planning the sales of 25 000 systems a year. The costs of market
research was $100 000 and this money is already spent. The price of the product is 100$. The
duration of the project is 5 years. The variable costs are estimated 40% of the sales price. The
fixed costs are 325 000 per year (excl. depreciation). The investment into fixed assets is 2.5
million, is fully amortised in 5 years, and has no market value at the end of the project.
The need for investments
into current assets is expected to be 15% of the sales. The firm expects that all investments into
current assets can be converted into cash at the end of the project. The corporate tax rate on
profits is 25%.

a. Find the cash flows for the project


b. Should the company invest, if the required rate of return from the project is 12%. Compute
both NPV and IRR.

Solution 02
Years 1 2 3 4 5
No. of pieces sell in a year 25000 25000 25000 25000 25000
Product Cost (Per piece) 100 100 100 100 100
Total Sales Value 2500000 2500000 2500000 2500000 2500000
Variable Costs 1000000 1000000 1000000 1000000 1000000
Fixed Costs 325000 325000 325000 325000 325000
Annual Savings 1175000 1175000 1175000 1175000 1175000
Years 0 1 2 3 4 5
Starting Investments -2500000
Working Capital (15% of the sales Value) -375000
Annual Savings 1175000 1175000 1175000 1175000 1175000
Depreciation (5 Years-2.5 Million fully
500000 500000 500000 500000 500000
Amortised)
Income 675000 675000 675000 675000 675000
Tax (25% on Profit) 168750 168750 168750 168750 168750
Profit After Tax 506250 506250 506250 506250 506250
Non-Cash Depreciation 500000 500000 500000 500000 500000
Recovery of Capital 375000

Net Cash flow After Tax -2875000 1006250 1006250 1006250 1006250 1381250

Present Value need @ 12% of Sales 1 0.892857 0.797194 0.71178 0.635518 0.5674269

PV of Cash Flows -2875000 898437.5 802176.3 716228.9 639490.1 783758.34


Net Present Value 965091.124504135

Working for IRR


Years 0 1 2 3 4 5
Cash flows -2875000 1006250 1006250 1006250 1006250 1381250
IRR 24.25%

**NPV is Positive and IRR is also greater than 12% so company could invest in the
project.

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