Question

In: Finance

(Calculating project cash flows and​ NPV) You are considering expanding your product line that currently consists...

(Calculating project cash flows and​ NPV) You are considering expanding your product line that currently consists of skateboards to include​ gas-powered skateboards, and you feel you can sell 8,000 of these per year for 10 years​ (after which time this project is expected to shut down with​solar-powered skateboards taking​ over). The gas skateboards would sell for ​$70 each with variable costs of ​$30 for each one​ produced, and annual fixed costs associated with production would be $180,000. In​ addition, there would be a $1,200,000 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 10 years. The project will also require a​one-time initial investment of $60,000 in net working capital associated with​ inventory, and this working capital investment will be recovered when the project is shut down. ​ Finally, assume that the​ firm's marginal tax rate is 30 percent.

a.What is the initial cash outlay associated with this​ project?

b.What are the annual net cash flows associated with this project for years 1 through 99​?

c.What is the terminal cash flow in year 10 (that is, what is the free cash flow in year 10 plus any additional cash flows associated with termination of the​ project)?

d.What is the​ project's NPV given a required rate of return of 13 percent​?

Solutions

Expert Solution

Time line 0 1 2 3 4 5 6 7 8 9 10
Cost of new machine -1200000
Initial working capital -60000
=Initial Investment outlay a. -1260000
Unit sales 8000 8000 8000 8000 8000 8000 8000 8000 8000 8000
Profits =no. of units sold * (sales price - variable cost) 320000 320000 320000 320000 320000 320000 320000 320000 320000 320000
Fixed cost -180000 -180000 -180000 -180000 -180000 -180000 -180000 -180000 -180000 -180000
-Depreciation Cost of equipment/no. of years -120000 -120000 -120000 -120000 -120000 -120000 -120000 -120000 -120000 -120000
=Pretax cash flows 20000 20000 20000 20000 20000 20000 20000 20000 20000 20000
-taxes =(Pretax cash flows)*(1-tax) 14000 14000 14000 14000 14000 14000 14000 14000 14000 14000
+Depreciation 120000 120000 120000 120000 120000 120000 120000 120000 120000 120000
=after tax operating cash flow b. 134000 134000 134000 134000 134000 134000 134000 134000 134000 134000
reversal of working capital 60000
+Tax shield on salvage book value =Salvage value * tax rate 0
=Terminal year after tax cash flows 60000
Total Cash flow for the period -1260000 134000 134000 134000 134000 134000 134000 134000 134000 134000 c. 194000
Discount factor= (1+discount rate)^corresponding period 1 1.13 1.2769 1.442897 1.6304736 1.8424352 2.0819518 2.352605 2.65844 3.004042 3.394567
Discounted CF= Cashflow/discount factor -1260000 118584.07 104941.656 92868.722 82184.71 72729.831 64362.683 56958.13 50405.4 44606.57 57150.14
d. NPV= Sum of discounted CF= -515208.0733

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