Question

Related to Checkpoint​ 12.1)  ​(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 comma 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 ​$120 each with variable costs of ​$25 for each one​ produced, and annual fixed costs associated with production would be ​$150 comma 000. In​ addition, there would be a ​$1 comma 400 comma 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 $ 30 comma 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 9​?

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 the termination of the​ project)? d.  What is the​ project's NPV given a required rate of return of 8 percent​?

Answer 1

Time line		0	1	2	3	4	5	6	7	8	9	10
Cost of new machine		-1400000
Initial working capital		-30000
=a. Initial Investment outlay		-1430000
Unit sales			8000	8000	8000	8000	8000	8000	8000	8000	8000	8000
Profits	=no. of units sold * (sales price - variable cost)		760000	760000	760000	760000	760000	760000	760000	760000	760000	760000
Fixed cost			-150000	-150000	-150000	-150000	-150000	-150000	-150000	-150000	-150000	-150000
-Depreciation	Cost of equipment/no. of years		-140000	-140000	-140000	-140000	-140000	-140000	-140000	-140000	-140000	-140000
=Pretax cash flows			470000	470000	470000	470000	470000	470000	470000	470000	470000	470000
-taxes	=(Pretax cash flows)*(1-tax)		329000	329000	329000	329000	329000	329000	329000	329000	329000	329000
+Depreciation			140000	140000	140000	140000	140000	140000	140000	140000	140000	140000
=b. after tax operating cash flow			469000	469000	469000	469000	469000	469000	469000	469000	469000	469000
reversal of working capital												30000
+Tax shield on salvage book value	=Salvage value * tax rate											0
=Terminal year after tax cash flows												30000
Total Cash flow for the period		-1430000	469000	469000	469000	469000	469000	469000	469000	469000	469000	c. 499000
Discount factor=	(1+discount rate)^corresponding period	1	1.08	1.1664	1.259712	1.36048896	1.4693281	1.5868743	1.713824	1.85093	1.999005	2.158925
Discounted CF=	Cashflow/discount factor	-1430000	434259.2593	402091.907	372307.321	344729.001	319193.52	295549.56	273657	253386.1	234616.8	231133.6
d. NPV=	Sum of discounted CF=	1730923.981