Question

You are considering expanding your product line that currently consists of skateboards to include gas-powered skateboards, and you feel you can sell 12000 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 $110 each with variable costs of $25 for each one produced, and annual fixed costs associated with production would be $150000. In addition, there would be a $1 comma 400000 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 $ 40000 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 38 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 termination of the project)? d. What is the project's NPV given a required rate of return of 13 percent ? a. The initial cash outlay associated with this project is $ 1440000. (Round to the nearest dollar.) b. The annual net cash flows associated with this project for years 1 through 9 are ?

Answer 1

Time line		0	1	2	3	4	5	6	7	8	9	10
Cost of new machine		-1400000
Initial working capital		-40000
=a. Initial Investment outlay		-1440000
Unit sales			12000	12000	12000	12000	12000	12000	12000	12000	12000	12000
Profits	=no. of units sold * (sales price - variable cost)		1020000	1020000	1020000	1020000	1020000	1020000	1020000	1020000	1020000	1020000
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			730000	730000	730000	730000	730000	730000	730000	730000	730000	730000
-taxes	=(Pretax cash flows)*(1-tax)		452600	452600	452600	452600	452600	452600	452600	452600	452600	452600
+Depreciation			140000	140000	140000	140000	140000	140000	140000	140000	140000	140000
=after tax operating cash flow			b. 592600	592600	592600	592600	592600	592600	592600	592600	592600	592600
reversal of working capital												40000
+Tax shield on salvage book value	=Salvage value * tax rate											0
=Terminal year after tax cash flows												40000
Total Cash flow for the period		-1440000	592600	592600	592600	592600	592600	592600	592600	592600	592600	c. 632600
Discount factor=	(1+discount rate)^corresponding period	1	1.13	1.2769	1.442897	1.63047361	1.8424352	2.0819518	2.352605	2.658444	3.004042	3.394567
Discounted CF=	Cashflow/discount factor	-1440000	524424.7788	464092.725	410701.526	363452.678	321639.54	284636.76	251890.9	222912.3	197267.6	186356.6
d. NPV=	Sum of discounted CF=	1787375