Question

Revenues generated by a new fad product are forecast as follows: Year Revenues 1 $50,000 2 35,000 3 30,000 4 20,000 Thereafter 0 Expenses are expected to be 40% of revenues, and working capital required in each year is expected to be 20% of revenues in the following year. The product requires an immediate investment of $60,000 in plant and equipment. 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. (Do not round intermediate calculations.) c. If the opportunity cost of capital is 10%, what is the project's NPV? (A negative value should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.) d. What is project IRR? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

	Year	Initial cash flow	Revenues	Expenses at 40%	NWC at 20% of next year revenues	net increase or decrease in NWC		Depreciation per year
	0	-60000			10000	-10000		60000/4
	1		$50,000	$            20,000	7000	3000		15000
	2		35000	$            14,000	6000	1000		tax saving
	3		30000	$            12,000	4000	2000		15000 x 20%
	4		20000	$              8,000	0	4000		3000
	Thereafter		0	$                     -
a.	Initial nvestment		$        70,000
	(60000+10000)
b.	Year	Cash flows
	1	(50000-20000)(1-0.20)+3000+3000 =			30,000
	2	(35000-14000)(1-0.20)+1000+3000 =			20,800
	3	(30000-12000)(1-0.20)+2000+3000 =			19,400
	4	(20000-8000)(1-0.20)+4000+3000 =			16,600
c.	Year	Cash flows	DF at 10%	Present value
	0	-70000	1	(70,000.00)
	1	30000	0.90909091	27,272.73
	2	20800	0.82644628	17,190.08
	3	19400	0.7513148	14,575.51
	4	16600	0.68301346	11,338.02
			NPV =	$            376.34
d.	Year	Cash flows
	0	-70000
	1	30000
	2	20800
	3	19400
	4	16600
	IRR =	10.28%
		=IRR(Values 0 to 4)