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Ross corporation examines the introduction of a new product. The initial investment is estimated at 20 million. Furthermore, the net working capital requirements of the project requires are equal to 20% of the projected annual sales at the beginning of each year. The base scenario concerning the project assumes also the following Product selling price first year 45,000 per unit Variable costs first year 35,000 per unit Fixed costs first year 2 million After first year, price, variable and fixed costs will increase with inflation Estimated inflation rate 4% Projects life 4 years Estimated sales per year 1,200 units Depreciation rates per year: 20%, 32%, 19.20%, I 1.52% The company estimates that the equipment will have at the end of the projects 4 year life a market value of 800,000 . Tax rate 35%. Cost of capital 12% . a. Estimate the projects NPV, IRR, and pay-back. b. Besides the base scenario you are required to perform a sensitivity analysis, in order to determine the changes of the Net Present Value to variation in certain key variables of the project, namely the selling price of the new product, its variable costs per unit, and finally the number of units sold. You should assume a 10% and 20% change of the key variables above and below the base-case scenario values. Include a graph in your analysis Note: all calculations should be provided Part B Assume that tax authorities decided to shorten depreciation lives for tax purposes. Discuss this would affect the NPV and the IRR of an investment project (assuming all other parameters of the project remain unchanged). (200 words)

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For NPV, IRR and Payback period to be calculated free cash flow can be calculated as follows: Free Cash FlowOperating Cash Flow - Capital Expenditures - Change in working capital Operating Cash Flow EBIT (1-Tax Rate)+Depreciation Initial investment Number of units sold Price Per unit Life of the project Cost of Capital Tax rate Inflation rate Market value at the end of year 4 $20,000,000.00 $45,000.00 4 years 12 $800,000.00 15 Depreciation expense can be calculted as follows: Year Depreciation rate Depreciation Expense Book Value 20% 4,000,000 16,000,000 19.20% 3,840,000 5,760,000 11.52% 2,304,000 3,456,000 6,400,000 9,600,000 20,000,00016, Net Proceed from sale of assets calculation: Proceed from sale of asset at the end of 4th year Book Value of asset at year4 Gain or Loss on sale of System 25 3,456,000 -Proceed From Sale Book value at the end of sale ($2,656,000) D24-D25 Gain or Loss on sale of Machine Tax on Gain & Loss Net Proceed from Sale of System ($2,656,000) ($929,600) -Proceed from Sale - Tax Expense on gain or loss 1,729,600D24-D30 Free cash Flow calculation: Free cash flow can be calculated as followed: Year Units Sold Price per unit Revenue Variable Costs Fixed costs Depreciation Expense EBIT EBIT (1-Tax rate Add: Depre Operating Cash Flow Initial investment Net working Capital Change in working capital After tax proceed from sales of assets Free Cash Flow 1,200 46,800 $54,000,000 $56,160,000 1,200 45,000 1,200 48,672 ,406,400 1,200 50,619 60,742,656 ($42,000,000($43,680,000)($45,427,200)($47,244,288 $2,249,728 ($2,304,000 $8,944,640 $5,814,016 2,304,000 $8,118,016 $58 ($2,000,000)($2,080,000)($2,163,200) ($4,000,000($6,400,000)($3,840,000) $6,000,000 $4,000,000$6,976,000 $3,900,000 $2,600,000$4,534,400 $4,000,000 $6,400,000$3,840,000 $7,900,000 $9,000,000$8,374,400 45 ciation $20,000,000 $10,800,000 $11,232,000$11,681,280 $12,148,531 ($467,251$12,148,531 1,729,600 ($30,800,000)$7,468,000$8,550,720 $7,907,149 $20,266,547 $10,800,000) $432,000 $449,280A1 53 NPV Calculation: NPV of the project is present value of future cash flows discounted at required rate of return less the initial investment. Given the following cash flow and MARR, NPV for the project can be calculated as follows: Year Free Cash Flow (FCF MARR (i) P/F,i,n) for each year Present Value of cash flows FCF* (P/F,i,n Present value if future cash flows 54 4 57 ($30,800,000)$7,468,000$8,550,720 $7,907,149 $20,266,547 12% 59 0.89 0.80 0.71 0.64 $6,667,857.14 $6,816,581.63 $5,628,152.33 $12,879,757.13 61 $31,992,348.24-SUM(E60:H60 63 NPV for Project -Present value fo future cash flows- Initial investment $1,192,348.24D61+D57 Hence NPV of the proiect is $1,192,348.24 Calculation of IRR: IRR is the rate at which NPV of the project will be zero Given the following cash flow IRR can be calculated as below: 69 70 71 72 73 74 75 76 Year 4 Cash Flow ($30,800,000)$7,468,000$8,550,720 $7,907,149 $20,266,547 IRR can be found using IRR function in excel as follows: Year Cash Flow IRR $30,800,000)$7,468,000$8,550,720 $7,907,149 $20,266,547 13.55%-IRR(D78:H78 81 Hence IRR of the project 13.55% Calculation of Payback period Payback period is the period when investment amount is recovered Year Free Cash Flow Cumulative cash flow 83 4 $30,800,000)$7,468,000$8,550,720 $7,907,149 $20,266,547 ($30,800,000($23,332,000)($14,781,280)($6,874,131) 87 $13,392,416 91 92 93 Since the Payback period is when cumulative free cash flow becomes zero and it can be seen from above that cumulative cash flow becomes zero between year 3 and year 4 therefore the payaback period will be in between year 3 and 4. To estimate the exact payback period cumulative free cash flow can be proprated over the years as follows: Payback period 3.34 G85+(0-G87/(H87-G87) 95 Hence Payback period is 3.34 Years

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