Question

FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $200,000 per year. Once in production, the bike is expected to make $300,000 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 14%? 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

1)

10 300000 11 300000 -200000 -200000 -200000 -200000 -200000 -200000 300000 300000 300000 Fast Track Bikes Cash flows Cost of capital NPV of cash flows IRR of cash flows Scenario Manager ? X $ 10% 1,69,482.24 12.66% Scenarios: 10% 14% Add... Delete

2)

Cost of capital estimate should change in 12.66% -10% = 2.66% to effect change in the decision as IRR is 12.66%

3)

-200000 -200000 -200000 -200000 -200000 -200000 300000 300000 300000 300000 300000 Fast Track Bikes Cash flows Cost of capital NPV of cash flows IRR of cash flows Scenario Manager ? X $ 14% -64,815.87 12.66% Scenarios: 10% 14% Add... Delete

Formulae

A B F =C1609+1 =C1610 =D1609+1 =D1610 =E1609+1 =E1610 1-200000 -200000 1609 Fast Track Bikes 1610 Cash flows 1611 Cost of capital 1612 NPV of cash flows 1613 IRR of cash flows 0.1 =NPV(B1611, C1610:R1610) =IRR(C1610:R1610)