Question

Every two years, Warrior Lacrosse develops a new lacrosse stick design. Over the past year, the company has invested $25,000 in their latest stick, the Warrior-X. In addition, the firm has hired a consultant, for $10,000 to determine whether there will be a market for the stick. The consultant has advised the firm to go ahead and start production. Warrior expects to the new equipment needed to mold the stick to cost $500,000. The equipment will be depreciated using 3-year MACRS. In three years, Warrior plans to sell the equipment for $25,000. The company expects to produce sell the new stick line for 3 years. They predict that they can sell 300,000 sticks for $200 each in each of the three years. During the first year, they company expects sales from its current model, Warrior-Cradle to decline by $100,000. After that, the Warrior Cradle will no longer be produced. The company predicts that operating costs for the Warrior-X will be 25% of sales. If the company’s tax rate is .21 and their required return is .09, should the stick be produced? Please show the project’s NPV, IRR and Profitability Index

3- year MACRS Depreciation

(1) .3333

(2) .4444

(3) .1482

(4) .0742

Please base your answers to questions 2-6 on the information, below, for Projects A and B

	A	B
0	-90000	-2500
1	25000	1500
2	50000	1500
3	50000	1500
4	50000	1500
NPV PROFILE k	NPV’s for A	NPV’s for B
0.05	$63,488.00	$2,818.93
0.075	$54,210.50	$2,523.99
0.08	$52,458.19	$2,468.19
0.1	$45,766.00	$2,254.80
0.125	$38,059.75	$2,008.46
0.15	$31,009.79	$1,782.47
IRRs	29%	47%

Question 2

If the required return for both projects A and B is 8% and the projects are mutually exclusive, which project(s) should be selected?

Answer 1

Warrior-X NPV, IRR & Profitability index:

Formula	Year (n)	0	1	2	3
	Initial investment (II)	(500,000)
	Units sold per year (u)		300,000	300,000	300,000
	Price per unit (p)		200	200	200
u*p	Sales (S)		60,000,000	60,000,000	60,000,000
	Lost sales (L)		(100,000)
25%*S	Operating cost (OC)		(15,000,000)	(15,000,000)	(15,000,000)
	Depreciation rate ('r)		0.3333	0.4444	0.1482
II*r	Depreciation (D)		(166,650)	(222,200)	(74,100)
S - L - OC -D	EBIT		44,733,350	44,777,800	44,925,900
EBIT*21%	Tax @ 21%		(9,394,004)	(9,403,338)	(9,434,439)
EBIT - Tax	Net income (NI)		35,339,347	35,374,462	35,491,461
	Add: depreciation (D)		1,66,650	2,22,200	74,100
NI + D	Operating Cash Flow (OCF)		35,505,997	35,596,662	35,565,561
II - Sum of Depreciation	Book value (BV)				37,050
SV - (SV - BV)*Tax rate	After-tax salvage value (ASV)				27,531
II + OCF + ASV	Free Cash Flow (FCF)	(500,000)	35,505,997	35,596,662	35,593,092
1/(a+d)^n	Discount factor @ 9%	1.000	0.917	0.842	0.772
FCF*Discount factor	PV of FCF	(500,000)	32,574,309	29,960,998	27,484,397
Sum of all PVs	NPV	89,519,704
Using IRR function & FCFs	IRR	7101%
PV of Future cash flows/II	Profitability Index	180.04

Note: Can you please check the numbers which you have provided in the question, for any typos? The NPV, IRR numbers are quite high for this project.