Question

At​ present, Solartech Skateboards is considering expanding its product line to include​ gas-powered skateboards;​ however, it is questionable how well they will be received by skateboarders. Although you feel there is a 60 percent chance you will sell 10,000 of these per year for 10 years​ (after which time this project is expected to shut down because​ solar-powered skateboards will become more​ popular), you also recognize that there is a 20 percent chance that you will only sell 3,000 and also a 20 percent chance you will sell 13,000. The gas skateboards would sell for $ 100 each and have a variable cost of ​$40 each. Regardless of how many you​ sell, the annual fixed costs associated with production would be ​$160,000. In​ addition, there would be an initial expenditure of ​$1,000,000 associated with the purchase of new production equipment which will be depreciated using the bonus depreciation method in year 1. Because of the number of stores that will need​ inventory, the working capital requirements are the same regardless of the level of sales. This project will require a​ one-time initial investment of $ 50,000 in net working​ capital, and​ working-capital investment will be recovered when the project is shut down.​ Finally, assume that the​ firm's marginal tax rate is 21 percent.

a. What is the initial outlay associated with the​ project?

b. What are the annual free cash flows associated with the project for years​ 1, and 2 through 9 under each sales​ forecast? What are the expected annual free cash flows for year​ 1, and years 2 through​ 9?

c. What is the terminal cash flow in year 10​ (that is, what is the free cash flow in year 10 plus any additional cash flows associated with the termination of the​ project)?

d. Using the expected free cash​ flows, what is the​ project's NPV given a required rate of return of 10 ​percent? What would the​ project's NPV be if 10,000 skateboards were​ sold?

Answer 1

if 10,000 units were sold: