Question

FastTrack​ Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $223,000 per year. Once in​ production, the bike is expected to make $ 356,800 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

Computation of present value
year	Cash flow	PVIF @10%	Present value
1	-223000	0.9091	(202,727)
2	-223000	0.8264	(184,298)
3	-223000	0.7513	(167,543)
4	-223000	0.6830	(152,312)
5	-223000	0.6209	(138,465)
6	-223000	0.5645	(125,878)
7	356,800	0.5132	183,095
8	356,800	0.4665	166,450
9	356,800	0.4241	151,318
10	356,800	0.3855	137,562
11	356,800	0.3505	125,056
12	356,800	0.3186	113,687
13	356,800	0.2897	103,352
14	356,800	0.2633	93,957
15	356,800	0.2394	85,415
16	356,800	0.2176	77,650
Net present value			266,319
negative values are cash outflow and positive values are cash inflows.
Answer a) NPV =			266,319
Answer b) IRR = rate at which present value of cash flow = present value of cash outflow
using excel formula we have			13.65%
if cost of capital increases above 13.65% (or increased by more than 3.65% vs currnet 10%) decision will change .
Answer C) NPV of the investment if the cost of capital is 15%
year	Cash flow	PVIF @15%	Present value
1	-223000	0.8696	(193,913)
2	-223000	0.7561	(168,620)
3	-223000	0.6575	(146,626)
4	-223000	0.5718	(127,501)
5	-223000	0.4972	(110,870)
6	-223000	0.4323	(96,409)
7	356,800	0.3759	134,134
8	356,800	0.3269	116,639
9	356,800	0.2843	101,425
10	356,800	0.2472	88,196
11	356,800	0.2149	76,692
12	356,800	0.1869	66,688
13	356,800	0.1625	57,990
14	356,800	0.1413	50,426
15	356,800	0.1229	43,849
16	356,800	0.1069	38,129
Net present value			(69,772)
NPV is negative @ 15% discount rate =			(69,772)