Question

A firm is considering a project that involves the production and sale of a new product over the next five years. This product's sales are expected to be 200000 units a year at a selling price of $80 per unit. The fixed operating expenses ( excluding depreciation ) are expected to increase by $8 million a year and variable operating expenses to decrease by $2 million a year. In addition, the product will require additional equipment to be purchased today at a cost of $6 million. There is $1 million salvage value expected at the end of five years. The firm uses straight-line depreciation and is in the 40% tax bracket. In addition, the project will require working capital of 10% of sales each year.

The tax-rate is 40% The firm plans to raise the $3 million for equipment by borrowing the money for five years at 8%. The firm spent $500,000 last year test marketing the product, and the product is expected to reduce sales of the firm's other products by $550,000 a year.

1- Calculate the expected cash flows for each year of this project's life ( i.e. from year 0 to year 5
2- Find the NPV if the required return is %10.
3- Find the IRR.
4- Find the Profitability Index.

Redo this problem assuming that the firm will sell an old machine with a remaining lif of five years for $600,000. This machine has no salvage value. It was purshased 3 years ago for $400,000 and a zero salvage value.

Answer 1

Note: IRR is calcualted by =IRR(cash flow range) function of excel

Depriciation= (Cost of equipment $6million - Salvage Value $1million ) / Number of years 5