Question

You are the CFO of Carla Vista, Inc., a retailer of the exercise machine Slimbody6 and related accessories. Your firm is considering opening up a new store in Los Angeles. The store will have a life of 20 years. It will generate annual sales of 4,400 exercise machines, and the price of each machine is $2,500. The annual sales of accessories will be $600,000, and the operating expenses of running the store, including labor and rent, will amount to 50 percent of the revenues from the exercise machines. The initial investment in the store will equal $33,500,000 and will be fully depreciated on a straight-line basis over the 20-year life of the store. Your firm will need to invest $2,500,000 in additional working capital immediately, and recover it at the end of the investment. Your firm’s marginal tax rate is 30 percent. The opportunity cost of opening up the store is 17.40 percent. What are the incremental free cash flows from this project at the beginning of the project? In years 1–19 and 20? (Do not round intermediate calculations. Round NPV answer to 2 decimal places, e.g. 5,265.25 and all other answers to the nearest dollar, e.g. 5,265.)

Incremental cash flow at the beginning of the project $?

Incremental cash flow in the years 1-19 $?

Incremental cash flow in the year 20 $?

NPV of the project $?

Answer 1

Part (a):
Incremental Cashflow at the begininng of Project
Particulars	Year 0
Investment in Store	33,500,000
Working Capital Investment	2,500,000
Total Investment	36,000,000

Part (b):
Incremental Cashflow in the year 1-19
Particulars	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15	16	17	18	19
Revenue from Sale of Exercise Machines (4400 * $2500)	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000	11,000,000
Revenue from Sale of Accessories	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000
Less: Operating Costs (Revenue from sale of Exercise machines*50%)	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000	5,500,000
Less: Depreciation	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000
Earnings Before Tax	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000	4,425,000
Less: Tax@30%	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500	1,327,500
Earnings After Tax	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500	3,097,500
Addback Depreciation	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000	1,675,000
Net Operating Cashflows	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500	4,772,500

Part (c ):
Calculation of Incremental Cashflow at year 20
Particulars	Year 20
Revenue from Sale of Exercise Machines (4400 * $2500)	11,000,000
Revenue from Sale of Accessories	600,000
Less: Operating Costs (Revenue from sale of Exercise machines*50%)	5,500,000
Less: Depreciation	154,875
Earnings Before Tax	5,945,125
Less: Tax@30%	1,783,538
Earnings After Tax	4,161,588
Addback Depreciation	154,875
Net Operating Cashflows	4,316,463
Net Working Capital Realized	2,500,000
Total Incremental Cashflows	6,816,463

Part (d):
Calculation of NPV of the Project
Year	Cashflows	PV @17.4%	Discounted Cashflows
0	-36,000,000	1	-36,000,000
1	4,772,500	0.851788756	4,065,161.84
2	4,772,500	0.725544086	3,462,659.15
3	4,772,500	0.618010294	2,949,454.13
4	4,772,500	0.52641422	2,512,311.87
5	4,772,500	0.448393714	2,139,959.00
6	4,772,500	0.381936724	1,822,793.01
7	4,772,500	0.325329407	1,552,634.60
8	4,772,500	0.277111931	1,322,516.69
9	4,772,500	0.236040827	1,126,504.85
10	4,772,500	0.201056923	959,544.16
11	4,772,500	0.171258026	817,328.93
12	4,772,500	0.145875661	696,191.59
13	4,772,500	0.124255248	593,008.17
14	4,772,500	0.105839223	505,117.69
15	4,772,500	0.09015266	430,253.57
16	4,772,500	0.076791022	366,485.15
17	4,772,500	0.065409729	312,167.93
18	4,772,500	0.055715272	265,901.14
19	4,772,500	0.047457642	226,491.60
20	6,816,463	0.040423886	275,547.90
NPV of the Project	-9,597,967