Question

(Related to Checkpoint 12.1) (Comprehensive problem-calculating project cash flows, NPV, PI, and IRR) Traid Winds Corporation, a firm in the 36 percent marginal tax bracket with a required rate of return or discount rate of 13 percent, is considering a new project. This project involves the introduction of a new product. The project is expected to last 5 years and then, because this is somewhat of a fad product, it will be terminated. Given the following information, E, determine the free cash flows associated with the project, the project's net present value, the profitability index, and the internal rate of return. Apply the appropriate decision criteria. percent value the profitability inde cand the internal rate of rete a. Determine the free cash flows associated with the project. The FCF in year is $ . (Round to the nearest dollar.) Data Table Cost of new plant and equipment: Shipping and installation costs: Unit sales: $14,400,000 $180,000 Year Units Sold 75,000 115,000 115,000 85,000 75,000 Sales price per unit: Variable cost per unit: Annual fixed costs: Working-capital requirements: $310/unit in years 1 through 4, $260/unit in year 5 $160/unit $750,000 There will be an initial working capital requirement of $180,000 to get production started. For each year, the total investment in net working capital will be equal to 13 percent of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5. Use the simplified straight-line method over 5 years. It is assumed that the plant and equipment will have no salvage value after 5 years. The depreciation method: Print Done Enter your answer in the answer box and then click Check Answer.

Answer 1

	Years
I. Initial Outlay	0	1	2	3	4	5
Cost of new plant and equipment	-14,400,000
Shipping and Installation costs	-180,000
	-14,580,000
II. Project Performance
Units Sold (Given)	-	75,000	115,000	115,000	85,000	75,000
Unit Price (Given)	-	310	310	310	310	260
Unit Variable Cost (Given)	-	-160	-160	-160	-160	-160
Sales (Units Sold x Unit Price)	-	23,250,000	35,650,000	35,650,000	26,350,000	19,500,000
Variable Cost (Units Sold x Unit Price)	-	-12,000,000	-18,400,000	-18,400,000	-13,600,000	-12,000,000
Fixed Costs (Given)	-	-750,000	-750,000	-750,000	-750,000	-750,000
Depreciation (14,580,000 / 5)	-	-2,916,000	-2,916,000	-2,916,000	-2,916,000	-2,916,000
Earnings before Tax	-	7,584,000	13,584,000	13,584,000	9,084,000	3,834,000
Tax @ 36%	-	-2,730,240	-4,890,240	-4,890,240	-3,270,240	-1,380,240
Earnings after Tax	-	4,853,760	8,693,760	8,693,760	5,813,760	2,453,760
EarningAfterTax+Depreciation	-	7,769,760	11,609,760	11,609,760	8,729,760	5,369,760
III. Working Capital	-180,000	-2,842,500	-1,612,000	-	-	4,634,500
Free Cash Flow ( I + II + III )	-14,760,000	4,927,260	9,997,760	11,609,760	8,729,760	10,004,260
PV Factor @ 13%	1.0000	0.8850	0.7831	0.6931	0.6133	0.5428
Discounted Cash Flow	-14,760,000	4,360,407	7,829,713	8,046,146	5,354,125	5,429,912
NPV (Sum of Discounted Cash Flow)	16,260,303
Profitability Index = Project Inflows (Year 1 to 5) / Initial Investment (Year 0)	2.10

PV Factor = 1/(1+13%)ⁿ

Working Capital Calculation

Year	Sales	Total Investment in Working Capital	Incremental WC required
0	-	180,000	180,000
1	23,250,000	3,022,500	2,842,500
2	35,650,000	4,634,500	1,612,000
3	35,650,000	4,634,500	-
4	26,350,000	3,425,500	-
5	19,500,000	2,535,000	-

Total Investment in WC for the first year is given in the question. From 2nd year onward it is calculated as 13% of sales.

Incremental WC is calculated as total Investment required for the current year minus total investments made in prior years.

In the fifth year WC invested will be recovered.

IRR is the rate at which the NPV becomes zero. Here IRR is ~ 47.77%

	0	1	2	3	4	5
Free Cash Flow ( I + II + III )	-14,760,000	4,927,260	9,997,760	11,609,760	8,729,760	10,004,260
PV Factor @ 13%	1.0000	0.6767	0.4579	0.3099	0.2097	0.1419
Discounted Cash Flow	-14,760,000	3,334,186	4,577,954	3,597,297	1,830,373	1,419,406
NPV (Sum of Discounted Cash Flow)	-785