Question

In: Finance

At​ present, Solartech Skateboards is considering expanding its product line to include​ gas-powered skateboards;​ however, it...

At​ present, Solartech Skateboards is considering expanding its product line to include​ gas-powered skateboards;​ however, it is questionable how well they will be received by skateboarders. Although you feel there is a 60 percent chance you will sell 9,000 of these per year for 10 years​ (after which time this project is expected to shut down because​ solar-powered skateboards will become more​ popular), you also recognize that there is a 20 percent chance that you will only sell 5,000 and also a 20 percent chance you will sell 16,000. The gas skateboards would sell for $110 each and have a variable cost of ​$40 each. Regardless of how many you​ sell, the annual fixed costs associated with production would be ​$120,000. In​ addition, there would be an initial expenditure of ​$1,200,000 associated with the purchase of new production equipment which will be depreciated using the bonus depreciation method in year 1. Because of the number of stores that will need​ inventory, the working capital requirements are the same regardless of the level of sales. This project will require a​ one-time initial investment of $30,000 in net working​ capital, and​ working-capital investment will be recovered when the project is shut down.​ Finally, assume that the​ firm's marginal tax rate is 26 percent.

a. What is the initial outlay associated with the​ project?

b. What are the annual free cash flows associated with the project for years​ 1, and 2 through 9 under each sales​ forecast? What are the expected annual free cash flows for year​ 1, and years 2 through​ 9?

c. What is the terminal cash flow in year 10​ (that is, what is the free cash flow in year 10 plus any additional cash flows associated with the termination of the​ project)?

d. Using the expected free cash​ flows, what is the​ project's NPV given a required rate of return of 9 ​percent? What would the​ project's NPV be if 9,000 skateboards were​ sold?

Solutions

Expert Solution

Part (a)

Initial outlay = cost of equipment + working capital investment = 1,200,000 + 30,000 = 1,230,000

Part (b)

Please see the table below. All financials are in $. Please see the second column to understand the mathematics. The cells colored in yellow contain your answers.

Sales forecast level N 9,000 5,000 16,000
Year Linkage                   1 2 to 9                   1 2 to 9                  1 2 to 9
Sales A = 110 x N       990,000 990,000       550,000       550,000 1,760,000 1,760,000
[-] Variable cost B = 40 x N       360,000 360,000       200,000       200,000      640,000      640,000
[-] Fixed costs C       120,000 120,000       120,000       120,000      120,000      120,000
[-] Depreciation D    1,200,000              -   1,200,000                  -   1,200,000                 -  
EBIT E = A - B - C - D      -690,000 510,000     -970,000       230,000     -200,000 1,000,000
[-] Taxes F = E x 26%      -179,400 132,600     -252,200         59,800       -52,000      260,000
NOPAT G = E - F      -510,600 377,400     -717,800       170,200     -148,000      740,000
Annual free cash flows H = G + D       689,400 377,400      482,200       170,200 1,052,000      740,000

Part (c)

Terminal cash flow in year 10 = Annual cash flows from year 9 + release of working capital of 30,000

Hence, for sales level of 9,000; year 10 terminal cash flows = 377,400 + 30,000 = 407,400

For sales level of 5,000; year 10 terminal cash flows = 170,200 + 30,000 = 200,200

and for sales level of 16,000; year 10 terminal cash flows = 740,000 + 30,000 = 770,000

Part (d)

NPV = - C0 + C1/(1 + r) + PV today of annual cash flow in year 2 to 9 as annuity + PV of C10 = - C0 + C1/(1 + r) + C/[r x (1 + r)] x [1 - (1 + r)-n] + C10 x (1 + r)-10

Scenario 1:

NPV1 = -1,230,000 + 689,400 / (1 + 9%) + 377,400 / [9% x (1 + 9%)] x [1 - (1 + 9%)-9] + 407,400 x (1 + 9%)-10 = $ 1,650,353

p1 = 60%

Scenario 2:

NPV2 = -1,230,000 + 482,200 / (1 + 9%) + 170,200 / [9% x (1 + 9%)] x [1 - (1 + 9%)-9] + 200,200 x (1 + 9%)-10 = $ 233,091

p2 = 20%

Scenario 3:

NPV3 = -1,230,000 + 1,052,000 / (1 + 9%) + 740,000 / [9% x (1 + 9%)] x [1 - (1 + 9%)-9] + 770,000 x (1 + 9%)-10 = $ 4,130,562

p3 = 20%

Hence, the project's expected NPV = p1 x NPV1 + p2 x NPV2 + p3 x NPV3 = 60% x 1,650,353 + 20% x 233,091 + 20% x 4,130,562 = $ 1,862,942

the​ project's NPV be if 9,000 skateboards were​ sold = NPV1 = $ 1,650,353


Related Solutions

At​ present, Solartech Skateboards is considering expanding its product line to include​ gas-powered skateboards;​ however, it...
At​ present, Solartech Skateboards is considering expanding its product line to include​ gas-powered skateboards;​ however, it is questionable how well they will be received by skateboarders. Although you feel there is a 40 percent chance you will sell 11,000 of these per year for 10 years​ (after which time this project is expected to shut down because​ solar-powered skateboards will become more​ popular), you also recognize that there is a 30 percent chance that you will only sell 3,000 and...
At​ present, Solartech Skateboards is considering expanding its product line to include​ gas-powered skateboards;​ however, it...
At​ present, Solartech Skateboards is considering expanding its product line to include​ gas-powered skateboards;​ however, it is questionable how well they will be received by skateboarders. Although you feel there is a 60 percent chance you will sell 10,000 of these per year for 10 years​ (after which time this project is expected to shut down because​ solar-powered skateboards will become more​ popular), you also recognize that there is a 20 percent chance that you will only sell 3,000 and...
(Calculating free cash flows​) At​ present, Solartech Skateboards is considering expanding its product line to include​gas-powered...
(Calculating free cash flows​) At​ present, Solartech Skateboards is considering expanding its product line to include​gas-powered skateboards;​ however, it is questionable how well they will be received by skateboarders. Although you feel there is a 50 percent chance you will sell 12,000 of these per year for 10 years​ (after which time this project is expected to shut down because​ solar-powered skateboards will become more​ popular), you also recognize that there is a 25 percent chance that you will only...
​(Calculating free cash flows​) At​ present, Solartech Skateboards is considering expanding its product line to include​...
​(Calculating free cash flows​) At​ present, Solartech Skateboards is considering expanding its product line to include​ gas-powered skateboards;​ however, it is questionable how well they will be received by skateboarders. Although you feel there is a 50 percent chance you will sell 10,000 of these per year for 10 years​ (after which time this project is expected to shut down because​ solar-powered skateboards will become more​ popular), you also recognize that there is a 25 percent chance that you will...
​(Calculating free cash flows​) At​ present, Solartech Skateboards is considering expanding its product line to include​...
​(Calculating free cash flows​) At​ present, Solartech Skateboards is considering expanding its product line to include​ gas-powered skateboards;​ however, it is questionable how well they will be received by skateboarders. Although you feel there is a 50 percent chance you will sell 12 comma 000 of these per year for 10 years​ (after which time this project is expected to shut down because​ solar-powered skateboards will become more​ popular), you also recognize that there is a 25 percent chance that...
(Calculating free cash flows​) At​ present, Solartech Skateboards is considering expanding its product line to include​...
(Calculating free cash flows​) At​ present, Solartech Skateboards is considering expanding its product line to include​ gas-powered skateboards;​ however, it is questionable how well they will be received by skateboarders. Although you feel there is a 70 percent chance you will sell 9,000 of these per year for 10 years​ (after which time this project is expected to shut down because​ solar-powered skateboards will become more​ popular), you also recognize that there is a 15 percent chance that you will...
You are considering expanding your product line that currently consists of skateboards to include​ gas-powered skateboards,...
You are considering expanding your product line that currently consists of skateboards to include​ gas-powered skateboards, and you feel you can sell 12,000 of these per year for 10 years​ (after which time this project is expected to shut down with​ solar-powered skateboards taking​ over). The gas skateboards would sell for ​$80 each with variable costs of ​$45 for each one​ produced, and annual fixed costs associated with production would be ​$180,000. In​ addition, there would be a ​$1,300,000 initial...
You are considering expanding your product line that currently consists of skateboards to include​ gas-powered skateboards,...
You are considering expanding your product line that currently consists of skateboards to include​ gas-powered skateboards, and you feel you can sell 9 comma 0009,000 of these per year for 1010 years​ (after which time this project is expected to shut down with​ solar-powered skateboards taking​ over). The gas skateboards would sell for ​$7070 each with variable costs of ​$4545 for each one​ produced, and annual fixed costs associated with production would be ​$180 comma 000180,000. In​ addition, there would...
You are considering expanding your product line that currently consists of skateboards to include gas-powered skateboards,...
You are considering expanding your product line that currently consists of skateboards to include gas-powered skateboards, and you feel you can sell 10,000 of these per year for 10 years (after which time this project is expected to shut down with solar-powered skateboards taking over). The gas skateboards would sell for $100 each with variable costs of $40 for each one produced, while annual fixed costs associated with production would be $160,000. In addition, there would be a $1,000,000 initial...
 You are considering expanding your product line that currently consists of skateboards to include​ gas-powered skateboards,...
 You are considering expanding your product line that currently consists of skateboards to include​ gas-powered skateboards, and you feel you can sell 11,000 of these per year for 10 years​ (after which time this project is expected to shut down with​ solar-powered skateboards taking​ over). The gas skateboards would sell for ​$90 each with variable costs of ​$30 for each one​ produced, and annual fixed costs associated with production would be ​$200,000. In​ addition, there would be a ​$1,200,000 initial...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT