Question

Revenues generated by a new fad product are forecast as follows:

Year	Revenues
1	$40,000
2	30,000
3	20,000
4	5,000
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 $49,000 in plant and equipment.

Required:

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.

Year Cash Flow 1 2 3 4

c. If the opportunity cost of capital is 10%, what is the project's NPV?

d. What is project IRR?

Answer 1

Question a:

Initial investment of the project is -$57,000

Quesiton b:

Project cash flows are as below

Year Cash Flows

1 $23,650

2 $18,850

3 $15,050

4 $5,850

Question c:

NPV of the Project is -$4,618.57

Question d:

IRR of the project is 5.40%