Question

Revenues generated by a new fad product are forecast as follows:

Year	Revenues
1	$60,000
2	45,000
3	30,000
4	10,000
Thereafter	0

Expenses are expected to be 40% 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 30%, 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.)

Year	Cash Flow
1
2
3
4

c. If the opportunity cost of capital is 15%, 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

solution: Plant equipment working capital =60000*20% Initial investment 60000 12000 72000 10000 1 60000 -24000 - 15000 21000 -6300 14700 150001 29700 3000 32700 Revenue Less : expense (Revenue x 40%) Less : Depreciation=60000/4 income before tax Less: tax at 30% net income Add : Depreciation OCF working capital changes net cash flow 23 45000 30000 -18000 -12000 -15000 -15000 12000 3000 -3600 8400 2100 15000 15000 23400 17100 3000 4000 26400 21100 -900 -4000 -15000 -9000 2700 -6300 15000 8700 2000 10700 net cash flow x discount factor at 15% PV NPV 0 -72000 1.00000 - 72,000.00 - 3,611.67 1 2 32700 26400 0.86957 | 0.75614 28,434.78 19,962.19 3 21100 0.65752 13,873.59 10700 0.57175 6,117.76

IRR using trial and error method year cash flow discount factor at 12% PV at 12% discount factor at 12.5% c=a*b -72000 1.00000 - 72,000.00 1.00000 32700 0.89286 29,196.43 0.88889 2 26400 0.7971921,045.92 0.79012 3 21100 0.71178 15,018.56 0.70233 4 10700 0.63552 16,800.04 0.62430 60.95 NPV By interpolation: IRR = 12.05% 12+(60.95*0.5/(60.95+5 74.91)) PV at 12.5% c=a*b - 72,000.00 29,066.67 20,859.26 14,819.20 6,679.96 - 574.91 NPV