Question

You work for Apple. After toiling away on $10.2 million worth of prototypes, you have finally produced your answer to Google Glasses: Glasses (the name alone is genius). Glasses will instantly transport the wearer into the world as Apple wants him to experience it: iTunes with the wink of an eye and apps that can be activated just by looking at them. You think that these will sell for five years until the next big thing comes along (or until users are unable to interact with actual human beings). Revenues are projected to be $444.7 million per year along with expenses of $354.7 million. You will need to spend $62.1 million immediately on additional equipment that will be depreciated using the 5-year MACRS schedule. Additionally, you will use some fully depreciated existing equipment that has a market value of $11 million. As the Glasses are an outcome of the R&D center, Apple plans to charge $4.6 million of the annual costs of the center to the iGlasses product for four years. Finally, Apple's working capital levels will increase from their current level of $117.9 million to $138.9 million immediately. They will remain at the elevated level until year 4, when they will return to $117.9 million. Apple's discount rate for this project is 14.4% and its tax rate is 35%. Calculate the free cash flows and determine the NPV of this project. (*) The opportunity cost must be after-tax. Note: Assume that the equipment is put into use in year 1.

Answer 1

As mentioned new product will be sold for 5 years, so we will calculate the Cash Flow for 5 Years. However there is R&D Exp and Working Capital change is applicable for 4 years only.

New Equipment Depreciation = 62.1 / 5 = 12.42

Opportunity Cost Calculation = Salvage Value - Tax Rate (Salvage Value - Book Value)

= 11 - .35(11-0) = 7.15 - As mentioned in questions this was in use for 1 year only.

Present Value Formula =P*((1-(1+r)^-n)/r)

Cash Flow Below table

			1	2	3	4	5
	Revenue		444.7	444.7	444.7	444.7	444.7
-	COGS		354.7	354.7	354.7	354.7	354.7
	Gross Profit		90	90	90	90	90
-	Annual Charges		4.6	4.6	4.6	4.6
-	Depreciation		12.42	12.42	12.42	12.42	12.42
	EBIT		72.98	72.98	72.98	72.98	77.58
-	Tax @ 35%		25.543	25.543	25.543	25.543	27.153
	Incremental Earning		47.437	47.437	47.437	47.437	50.427
+	Depreciation		12.42	12.42	12.42	12.42	12.42
-	Incremental Working Capital	-21				21
-	Capital Investment	-10.2
-	Opportunity Cost	-7.15	7.15
	Incremental Cash Flow	-38.35	67.007	59.857	59.857	80.857	62.847
	Discount Rate @ 14.4%
	Present Value	-38.35	58.57255	45.7365	39.97946	47.20777	32.0741
	NPV	185.2204

NPV Table at Y0

	Y0
Revenue	1512.128
COGS	1206.098
Gross Profit	306.03
Annual Charges	13.29391
Depreciation	42.23213
EBIT	250.5039
Tax @ 35%	87.67637
Incremental Earning	162.8275
Depreciation	42.23213
Incremental Working Capital	-8.7393
Capital Investment	-10.2
Opportunity Cost	-0.9
Incremental Cash Flow	185.2204

Hope this helps