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In: Finance

Related to Checkpoint​ 12.1)  ​(Calculating project cash flows and​ NPV)  You are considering expanding your product...

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​?

Solutions

Expert Solution

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

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