Question

 

FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $197,000 per year. Once in production, the bike is expected to make $295,500 per year for 10 years. Assume the cost of capital is 10%.

a. Calculate the NPV of this investment opportunity, assuming all cash flows occur at the end of each year. Should the company make the? investment?

b. By how much must the cost of capital estimate deviate to change the decision? (Hint: Use Excel to calculate the? IRR.)

c. What is the NPV of the investment if the cost of capital is 15%?

Note: Assume that all cash flows occur at the end of the appropriate year and that the inflows do not start until year 7.

Answer 1

Answer a						Answer c
Calculation of NPV						Calculation of NPV
Year	Cash flows	Discount factor @ 10%	Present Values			Year	Cash flows	Discount factor @ 15%	Present Values
1	-$197,000.00	0.909091	-$179,090.91			1	-$197,000.00	0.869565	-$171,304.35
2	-$197,000.00	0.826446	-$162,809.92			2	-$197,000.00	0.756144	-$148,960.30
3	-$197,000.00	0.751315	-$148,009.02			3	-$197,000.00	0.657516	-$129,530.70
4	-$197,000.00	0.683013	-$134,553.65			4	-$197,000.00	0.571753	-$112,635.39
5	-$197,000.00	0.620921	-$122,321.50			5	-$197,000.00	0.497177	-$97,943.82
6	-$197,000.00	0.564474	-$111,201.36			6	-$197,000.00	0.432328	-$85,168.54
7	$295,500.00	0.513158	$151,638.22			7	$295,500.00	0.375937	$111,089.40
8	$295,500.00	0.466507	$137,852.93			8	$295,500.00	0.326902	$96,599.47
9	$295,500.00	0.424098	$125,320.85			9	$295,500.00	0.284262	$83,999.54
10	$295,500.00	0.385543	$113,928.04			10	$295,500.00	0.247185	$73,043.08
11	$295,500.00	0.350494	$103,570.95			11	$295,500.00	0.214943	$63,515.72
12	$295,500.00	0.318631	$94,155.41			12	$295,500.00	0.186907	$55,231.06
13	$295,500.00	0.289664	$85,595.82			13	$295,500.00	0.162528	$48,027.01
14	$295,500.00	0.263331	$77,814.39			14	$295,500.00	0.141329	$41,762.62
15	$295,500.00	0.239392	$70,740.35			15	$295,500.00	0.122894	$36,315.32
16	$295,500.00	0.217629	$64,309.41			16	$295,500.00	0.106865	$31,578.54
NPV			$166,940.01			NPV			-$104,381.32
Yes , company should make investment as NPV is positive.
Answer b
Calculation of IRR of the project
IRR =	12.66%
The cost of capital estimate deviate between 10% to 12.66% to change the decision.