Question

Fast Bikes Ltd is a small manufacturer planning to start a revolutionary line of battery operated bikes.

To start the project, the firm needs to purchase manufacturing equipment worth $ 10 million today and also incur an additional $ 2 million in research and development costs.

The equipment will be depreciated in equal amounts over the next 10 years.

In the first year, the firm expects to sell 100 bikess at $ 25,000 each and the manufacturing cost is estimated to be $ 15,000 per bike.

As demand rises and processes are streamlined, the firm expects revenues to grow by 8% each year for the first 10 years and remain constant from the 11^th year onwards into the indefinite future

Over the same period, cost of manufacturing is expected to rise by only 3% per year and stabilize from the 11^th year onwards.

To guard against contingencies, the firm needs to set aside $ 2 million at the start of the project. However, as the project develops, the contingency amount can be reduced by              $ 200,000 each year.

From the 11^th year onwards, the firm does not envisage buying or selling off any additional equipment or incurring any costs beyond the cost of manufacturing the cars.

To fund the project the firm borrows $ 5 million from the bank which charges an interest rate of 4%. The loan will need to be repaid in equal-sized annual instalments over 10 years, starting in Year 1.

The rest of the funding comes from shareholders who expect an 10% return on their investment.

The corporate tax rate is 40% and expected to remain constant.

a) Using this data, work out the free cash flow of the project from year 0 to year 10 on an Excel spreadsheet. Clearly highlight all relevant inputs, adjustments and formulae for your calculation.           

b) Calculate the NPV of the project  

Note: The project doesn’t terminate in 10 years but continues into the indefinite future

Answer 1