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
jeff jeffy answered 1 year agoRelated Solutions
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