Question

It’s been two months since you took a position as an assistant financial analyst at NZ Products Ltd. Your boss has been pleased with your work and has asked you to evaluate the introduction of a new product under consideration. The new assignment involves the calculation of the cash flows associated with the new investment, providing a recommendation and responding to a number of questions about the investment process.

Since the new product has a brief life cycle that rises quickly in popularity but then declines just as quickly, the project is expected to last only 5 years before it is terminated. New equipment required for the new product will cost $12,500,000 and incur about $175,000 in shipping and installation costs. Estimated sales in number of units are 65,200 on average in years 1 to 5. The sales price is expected to be $290 per unit in years 1 to 4 and $210 per unit in year 5 due to lower demand. The variable cost is estimated to be $195 per unit and annual fixed costs $190,000. In addition, there will be an initial working capital requirement of $150,000 to get the production started. You should use the straight-line depreciation method over 5 years with zero salvage value after 5 years.

NZ Products Ltd has a marginal tax rate of 28% and a cost of capital of 16%.

a.       What is the project’s initial outlay?

b.      Calculate the free cash flows in year 1 through year 5. Show your workings.

c.       What is the net present value for this project? Show your workings.

d.      What is the payback period? Show your workings.

e.       Formulate a recommendation whether the project should be accepted, including why or why not.

Answer 1

a. Project's Initial Outlay is 12,825,000 ( 12,5000,000 + 175,000 + 150,000)