Question

​(Calculating free cash flows​) You are considering new elliptical trainers and you feel you can sell 3,000 of these per year for 5 years​ (after which time this project is expected to shut down when it is learned that being fit is​ unhealthy). The elliptical trainers would sell for ​$1,600 each and have a variable cost of ​$800 each. The annual fixed costs associated with production would be ​$1,300,000. In​ addition, there would be a ​$3,000,000 initial expenditure associated with the purchase of new production equipment. It is assumed that this initial expenditure will be depreciated using the simplified​ straight-line method down to zero over 5 years. This project will also require a​ one-time initial investment of ​$1,000,000 in net working capital associated with​ inventory, and that working capital investment will be recovered when the project is shut down.​ Finally, assume that the​ firm's marginal tax rate is 32 percent.
a. What is the initial outlay associated with this​ project?
b. What are the annual free cash flows associated with this project for years 1 through​ 4?
c. What is the terminal cash flow in year 5 ​(that is, what is the free cash flow in year 5 plus any additional cash flows associated with the termination of the​ project)?
d. What is the ​project's NPV given a required rate of return of 9 ​percent?

Answer 1

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