Question

This is the predicted cash flow stream of an investment project related to the launch of a new automotive vehicle for a fictitious firm:

Estimated Income Statement (simplified)
	YR0	YR1	YR2	YR3	YR4	YR5	YR6	YR7	YR8	YR9
Sales Forecast (units)		0	200	200	200	200	200	200	200	200
Unit Contribution ($)			$3300	$3300	$3300	$3300	$3300	$3300	$3300	$3300
Depreciation			200K	200K	200K	200K	200K
Free Cash (before taxes)	$-1M	$-2.5M	$710K	$710K	$710K	$710K	$710K	$510K	$510K	$510K

Be aware that this is a stylized Income Statement, designed for educational purposes, in order to force your critical thinking.  

Parameters considered in the DCF:

WACC = 9.5% (weighted average cost of capital)
Price = $22,000 /unit
Variable Costs = $18,700/unit
Fixed Costs = 150K
Investment = $3.5M (including the Cost of Equipment @$1M and R&D and Mkt expenses @$2.5M)

Supporting formulas:

a) free cash = unit contribution - Fixed Cost + Depreciation;

b) unit contribution = unit sales*(price - variable costs)

Note on the Investment and depreciation: the total initial investment was $3.5M, but $1M was paid in advance to purchase equipment and expand capacity. The remaining $2.5M was used in R&D and Marketing expenses paid at the end of Year #1. Manufacturing/sales effectively start in Year #2, so depreciation is initiated then for 5 consecutive years. The immediate investment cost of manufacturing is incurred in Time 0 and it is not affected by the discount rate (i.e., initial investment). Assume that production is interrupted in Year #10, with no residual value (the machinery cannot be sold due to high levels of specificity!).

Assignment Questions:

1) Based on the simplified information provided above, discuss whether you would support this investment. Why? or Why not? (Feel free to use Excel or a Financial Calculator)

Answer 1

Present value of each cash flow = cash flow / (1 + WACC)^year

The sum of present values is the NPV of the project

The NPV is -$51,147

As the NPV is negative, I would not support this investment