Question

In: Finance

Revenues generated by a new fad product are forecast as follows: Year Revenues 1 $45,000 2...

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

Year Revenues
1 $45,000
2 35,000
3 25,000
4 20,000
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 $60,000 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.

c. If the opportunity cost of capital is 12%, what is the project's NPV?

d. What is project IRR?

Solutions

Expert Solution

a

Initial investment = 60,000 + 45,000*20% = 69,000

b,c

Ref Particulars Year 1 Year 2 Year 3 Year 4
a Sales $       45,000.00 $               35,000.00 $      25,000.00 $      20,000.00
Expenses $      (18,000.00) $             (14,000.00) $     (10,000.00) $       (8,000.00)
b Depreciation $      (15,000.00) $             (15,000.00) $     (15,000.00) $     (15,000.00)
c=a-b Profit before tax $       12,000.00 $                 6,000.00 $                     -   $       (3,000.00)
Less: taxes $         2,400.00 $                 1,200.00 $                     -   $          (600.00)
Profit after tax $         9,600.00 $                 4,800.00 $                     -   $       (2,400.00)
Add: depreciation $       15,000.00 $               15,000.00 $      15,000.00 $      15,000.00
Add: working capital rec. $         2,000.00 $                 2,000.00 $         1,000.00 $         4,000.00
Project cash flow each year $       26,600.00 $              21,800.00 $      16,000.00 $      16,600.00
d Present value factor@ 12.0% 0.892857143 0.797193878 0.711780248 0.635518078
e=c*d Present value of annual cashflows $       23,750.00 $               17,378.83 $      11,388.48 $      10,549.60
Total present value of annual cash inflows $       63,066.91
Less: investment $       60,000.00
Working capital $         9,000.00
NPV $       (5,933.09)

d

IRR is 7.44% using excel


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