Question

You are the financial analyst for a tennis racket manufacturer. The company is considering using a graphitelike material in its tennis rackets. The company has estimated the information in the following table about the market for a racket with the new material. The company expects to sell the racket for six years. The equipment required for the project has no salvage value and will be depreciated on a straight-line basis. The required return for projects of this type is 13 percent, and the company has a 40 percent tax rate.

Calculate the NPV for each case for this project. Assume a negative taxable income generates a tax credit

		Pessimistic				Expected				Optimistic
	Market size		111,000				126,000				151,000
	Market share		20	%			23	%			25	%
	Selling price	$	156			$	161			$	167
	Variable costs per unit	$	110			$	105			$	104
	Fixed costs per year	$	971,000			$	926,000			$	896,000
	Initial investment	$	1,938,000			$	1,836,000			$	1,734,000

Answer 1

solution Pessimistic Expected Optimistic market size 111000 126000 151000 x market share 20% 23% 25% No of racket sold 22200 28980 37750 Depreciation 323,000.00 306,000.00 289,000.00 1836000/6 1938000/6 1734000/6 Pessimistic Optimistic calculation of NPV Expected Selling price Less variable cost per unit contribution margin x No of racket sold Total contribution margin PVIFA(13%, 6)(1-(1.13^a-6))/0.13 156 161 167 3.99755 formula (1-(1+r)A-n)/r -110 -105 -104 46 56 63 22200 28980 37750 1,021,200.00 1,622,880.00 2,378,250.00 Less fixed cost 926,000.00 971,000.00 896,000.00 Less Depreciation 323,000.00 306,000.00 289,000.00 income before tax 272,800.00 390,880.00 1,193,250.00 Less tax at 40% 109,120.00 156,352.00 477,300.00 net income 163,680.00 234,528.00 715,950.00 Add Depreciation 289,000.00 323,000.00 306,000.00 OCF 159,320.00 540,528.00 1,004,950.00 X PVIFA (13%,4)** 3.99755 3.99755 3.99755 PV of OCF 2,160,787.59 636,889.63 4,017,337.66 1,938,000.00 -1,836,000.00- 1,734,000.00 Less: Initial investment NPV -1,301,110.37 324,787.59 2,283,337.66