Question

FastTrack​ Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $183,000 per year. Once in​ production, the bike is expected to make $274,500 per year for 10 years. Assume the cost of capital is 10%. a. Calculate the NPV of this investment​ opportunity, assuming all cash flows occur at the end of each year. Should the company make the​ investment? b. By how much must the cost of capital estimate deviate to change the​ decision?​ (Hint: Use Excel to calculate the​ IRR.) c. What is the NPV of the investment if the cost of capital is 15%​? Note: Assume that all cash flows occur at the end of the appropriate year and that the inflows do not start until year 7.

FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $183,000 per year. Once in production, the bike is expected to make $274,500 per year for 10 years. Assume the cost of capital is 10%. a. Calculate the NPV of this investment opportunity, assuming all cash flows occur at the end of each year. Should the company make the investment? b. By how much must the cost of capital estimate deviate to change the decision? (Hint Use Excel to calculate the IRR.) c. What is the NPV of the investment if the cost of capital is 15%? Note: Assume that all cash flows occur at the end of the appropriate year and that the inflows do not start until year 7.

Answer 1

a)First Lets Calculate PV of Investment over 6 years:

=183000/(1.10)"1.....183000/(1.10)"6
=797,012.71

Now let's calculate PV of cash inflows that'll generated 7th year onwards

=274500/(1.10)"7...+274500/(1.10)"16
=952,088.96

So NPV is = 952088.96 - 797012.71

=155076.25

c)First Lets Calculate PV of Investment over 6 years when cost of capital is 15 %:

=183000/(1.15)"1.....183000/(1.15)"6
=595,596.97

Now let's calculate PV of cash inflows that'll generated 7th year onwards

=274500/(1.15)"7...+274500/(1.15)"16
=692,560.33

So NPV is = 595,596.97 - 692,560.33

that is negative so when cost of capital is 15 % this project should not be taken.

b) So when Cost of capital is 10% project is profitable as NPV is positive but when it's 15 %
NPV goes slightly negative so to change the decision cost of capital must deviate to
13.5-14 %.