NOWC and DCF Analysis
The Comstock Corporation is considering investing in a new floor mat manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0.
The floor mat manufacturing machine will result in new sales of 2,000 floor mats in year 1. Sales are estimated to grow by 10% per year each year through year three. Comstock will charge customers $18 per floor mat for all three years. The floor mats have a cost per unit to manufacture of $9 each. Incremental Selling, General & Administrative expenses are estimated to be $2,000 annually. Comstock spent $7,000 over the last year on the design of the new floor mats.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Comstock Corporation needs to hold 6% of its next year's annual sales in accounts receivable, 9% of its next year's annual sales in inventory, and 5% of its next year's annual sales in accounts payable.
The firm is in the 35% tax bracket, and has a cost of capital of 10%.
1. Calculate the required investment in NOWC for the three years of the project. Use these estimates of NOWC to calculate the Cash Flow from NOWC.
2. Use the 5 year financial projection template on Moodle to calculate the NOPAT, Free Cash Flow, NPV and IRR of the 3 year project using the NOWC estimates from above and changing depreciation to 1/3 each year.
3. Assume that Comstock must use the 5 year MACRS to depreciate the $30,000 machine, and will write it off after three years. Now the remaining depreciation and tax benefit must be recognized in year three. Calculate the new NOPAT, Free Cash Flow, NPV and IRR of the 3 year project. Explain the change in NPV.