Question

Violet Sky Entertainment is evaluating the trampoline park project, a 2-year project that would involve buying equipment for 54,000 dollars that would be depreciated to zero over 2 years using straight-line depreciation. Cash flows from capital spending would be $0 in year 1 and 5,000 dollars in year 2. Relevant annual revenues are expected to be 83,000 dollars in year 1 and 83,000 dollars in year 2. Relevant expected annual variable costs from the project are expected to be 10,000 dollars in year 1 and 10,000 dollars in year 2. Finally, the firm has no fixed costs in year 1 and one fixed cost in year 2 of the project. Yesterday, Violet Sky Entertainment signed a deal with Indigo River Marketing to develop an advertising campaign. The terms of the deal require Violet Sky Entertainment to pay Indigo River Marketing either 55,000 dollars in 2 years from today if the trampoline park project is pursued or 27,000 dollars in 2 years from today if the trampoline park project is not pursued. The tax rate is 40 percent and the cost of capital for the trampoline park project is 17.97 percent. What is the net present value of the trampoline park project?

Answer 1

Answer: NPV of trampoline park project is $35107
EXPLANATION:

Relevant cash flows in a given year = OCF + CF effects from ΔNet Working Capital (ΔNWC) + CF from capital spending + terminal value
In this problem, terminal value = 0
Therefore, relevant cash flows in a given year = OCF + CF from capital spending. We are given CF from capital spending.   We can compute OCF from revenue, costs, depreciation, and the tax rate
The calculation discounted cash flows is as follows:-

Discounted cash flow calculation

Year	0	1	2
Operating cashflow (OFC)
Revenue		$83,000	$83,000
variable cost		$10,000	$10,000
Depreciation ($54000 / 2)= $27000		$27,000	$27.000
EBIT = revenues – costs – depreciation		$46,000	$46,000
tax rate		.40	.40
Taxes = tax rate × EBIT		$18,400	$18,400
net income		$27,600	$27,600
OCF = net income + depreciation		$54,600	$54,600
Cash flows from capital spending	($54000)		$5000
Total cashflows	($54000)	$54600	$59600
PV of $1 Factor for 17.97	1	.8477	.7185
Discounted cashflows	($54000)	$46284.42	$42822.6

NPV = PV of future expected cashflows – initial investment

PV of future expected cashflows = ($46284.42+42822.6) = $89107

Initial investment = $54000

NPV = $89107 - $54000

NPV of trampoline park project is = $35107