Question

Revenues generated by a new fad product are forecast as follows: Year Revenues 1) $56,000 2) 40,000 3) 30,000 4) 20,000 Thereafter 0.

Expenses are expected to be 50% 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.

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 40%, what are the project cash flows in each year? Assume the plant and equipment are worthless at the end of 4 years. (Do not round intermediate calculations.)

c. If the opportunity cost of capital is 12%, what is the project's NPV? (A negative value should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

d. What is project IRR? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

Answer a:

Initial Investment:

Investment in plant and equipment = $60,000

Working capital = 20% of year 1 revenue = 20% * 56000 = $11,200

Initial investment in the product = 60000 + 11200 = $71,200

Answer b:

Project cash flows in each year are calculated below:

Answer c:

NPV = - $9,773.28

Workings:

Answer d:

As calculated above (in answer c):

IRR = 4.70%