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.

		Pessimistic				Expected				Optimistic
	Market size		108,000				123,000				148,000
	Market share		20	%			23	%			25	%
	Selling price	$	153			$	158			$	164
	Variable costs per unit	$	107			$	102			$	101
	Fixed costs per year	$	968,000			$	923,000			$	893,000
	Initial investment	$	1,920,000			$	1,818,000			$	1,716,000

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

Answer 1

solution: market size x market share No of racket sold Pessimistic 108,000 20% 21600 Expected Optimistic 123,000 148,000 23% 25% 2 8290 37000 Depreciation 320,000.00 1920000/6 303,000.00 1818000/6 286,000.00 1716000/6 Pessimistic Expected Optimistic 153 158 164 -107 -102 -101 46 56 63 calculation of NPV Selling price Less : variable cost per unit contribution margin x No of racket sold Total contribution margin Less : fixed cost Less : Depreciation income before tax Less : tax at 40% net income Add : Depreciation 21600 2 8290 37000 993600.00 1584240.00 2331000.00 -968000.00 -923000.00 -893000.00 -320000.00 -303000.00 -286000.00 -294400.00 358240.00 1152000.00 117760.00 -143296.00 -460800.00 -176640.00 214944.00 691200.00 320000.00 303000.00 286000.00 143360.00 517944.00 977200.00 3.99755 3.99755 3.99755 573088.74 2070506.93 3906405.65 -1920000.00 -1818000.00 -1716000.00 -1346911.26 252506.93 2190405.65 OCF X PVIFA(13%,6)** PV of OCF Less : Initial investment NPV **Factor working; PVIFA(13%,6) formula |(1-(1.134-6))/0.13_3.99755 (1-(1+r)^-n)/r