Question

Problem 9-14 Project Evaluation (LO2)

Revenues generated by a new fad product are forecast as follows:

Year	Revenues
1	$60,000
2	40,000
3	30,000
4	10,000
Thereafter	0

Expenses are expected to be 30% of revenues, and working capital required in each year is expected to be 10% of revenues in the following year. The product requires an immediate investment of $81,000 in plant and equipment.

Required:

a. What is the initial investment in the product? Remember working capital.

b. If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight-line depreciation, and the firm’s tax rate is 20%, what are the project cash flows in each year? Assume the plant and equipment are worthless at the end of 4 years.

c. If the opportunity cost of capital is 10%, what is the project's NPV?

d. What is project IRR?

Answer 1

Question a:

Initial investment in the product is -$87,000

Question b:

Cash Flow in Year 1 is $39,650

Cash Flow in Year 2 is $27,450

Cash Flow in Year 3 is $22,850

Cash Flow in Year 4 is $10,650

Question c:

Project's NPV is -$3,826.96

Question d:

Project's IRR is 7.50%