Question

You are the financial analyst for a tennis racket manufacturer. The company is considering using a graphite–like material in its tennis rackets. The company has estimated the information in the table below about the market for a racket with the new material. The company expects to sell the racket for six years. The equipment required for the project has no salvage value and will be depreciated on a straight-line basis. The required return for projects of this type is 13 percent, and the company has a 40 percent tax rate.

		Pessimistic				Expected				Optimistic
	Market size		123,000				138,000				163,000
	Market share		20	%			23	%			25	%
	Selling price	$	142			$	147			$	153
	Variable costs per unit	$	96			$	91			$	90
	Fixed costs per year	$	957,000			$	912,000			$	882,000
	Initial investment	$	1,860,000			$	1,758,000			$	1,656,000

Calculate the NPV for each case for this project. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Pessimistic		$
Expected		$
Optimistic		$

Answer 1

	Pessimistic	Expected	Optimistic
Market size [units]	123000	138000	163000
Market share %	20	23	25
Market share in units	24600	31740	40750
Selling price per unit	$ 142.00	$ 147.00	$ 153.00
Variable cost per unit	$ 96.00	$ 91.00	$ 90.00
Initial investment	$ 8,60,000.00	$ 17,58,000.00	$ 16,56,000.00
Life in years	6	6	6
Sales revenue	$ 34,93,200.00	$ 46,65,780.00	$ 62,34,750.00
-Total variable cost	$ 23,61,600.00	$ 28,88,340.00	$ 36,67,500.00
-Fixed cost	$       9,57,000.00	$    9,12,000.00	$    8,82,000.00
-Depreciation [Initial investment/6]	$       3,10,000.00	$    2,93,000.00	$    2,76,000.00
=NOI	$ -1,35,400.00	$    5,72,440.00	$ 14,09,250.00
-Tax at 40%	$         -54,160.00	$    2,28,976.00	$    5,63,700.00
=NOPAT	$         -81,240.00	$    3,43,464.00	$    8,45,550.00
+Depreciation	$       3,10,000.00	$    2,93,000.00	$    2,76,000.00
=OCF	$       2,28,760.00	$    6,36,464.00	$ 11,21,550.00
PVIFA(13,6)	3.99755	3.99755	3.99755
PV of OCF	$       9,14,479.54	$ 25,44,296.66	$ 44,83,452.20
Less: Initial investment	$ 18,60,000.00	$ 17,58,000.00	$ 16,56,000.00
NPV	$ -9,45,520.46	$    7,86,296.66	$ 28,27,452.20