Question

(Related to Checkpoint 12.1) (Calculating project cash flows and NPV) You are considering expanding your product line that currently consists of skateboards to include gas-powered skateboards, and you feel you can sell 12,000 of these per year for 10 years (after which time this project is expected to shut down with solar powered skateboards taking over). The gas skateboards would sell for $110 each with variable costs of $45 for each one produced, and annual fixed costs associated with production would be $190,000. In addition, there would be a $1,400,000 initial expenditure associated with the purchase of new production equipment. It is assumed that this initial expenditure will be depreciated using the simplified straight-line method down to zero over 10 years. The project will also require a one-time initial investment of $70,000 in not working capital associated with inventory, and this working capital investment will be recovered when the project is shut down. Finally, assume that the firm's marginal tax rate is 31 percent a. What is the initial cash outlay associated with this project? b. What are the annual net cash flows associated with this project for years 1 through 97 c. What is the terminal cash flow in year 10 (that is, what is the free cash flow in year 10 plus any additional cash flows associated with termination of the project)? d. What is the project's NPV given a required rate of return of 11 percent? a. The initial cash outlay associated with this project is $ . (Round to the nearest dollar.)

Answer 1

a. initial cash outlay = cost of equipment + investment in net working capital = $1,400,000 + $70,000 = $1,470,000

b. annual net cash flows is $450,500 associated with this project for years 1 through 9.

calculation of annual net cash flows is given in the table in part d.

c. terminal value of cash flow in year 10 = after-tax sale value of equipment + recovery of investment in net working capital

value of equipment at the end of project's life of 10 years is zero. so, after-tax sale value of equipment is zero.

terminal value of cash flow in year 10 = $0 + $70,000 = $70,000

d. NPV = sum of present value of annual cash flows - initial cash outlay

sum of present value of annual cash flows = year 1 annual cash flow/(1+required return) + year 2 annual cash flow/(1+required return)2 + year 3 annual cash flow/(1+required return)3 + .... year 10 annual cash flow/(1+required return)10

The project's NPV is $1,207,751.93 or $1,207,752.

	Years	0	1	2	3	4	5	6	7	8	9	10	Total
	Cost of equipmet	-$1,400,000	0	0	0	0	0	0	0	0	0	0	-$1,400,000
	Investment in NWC	-$70,000	0	0	0	0	0	0	0	0	0	0	-$70,000
	Sales quantity	0	12,000	12,000	12,000	12,000	12,000	12,000	12,000	12,000	12,000	12,000
	Sales price/unit	0	$110.00	$110.00	$110.00	$110.00	$110.00	$110.00	$110.00	$110.00	$110.00	$110.00
	Variable cost/unit	0	$45.00	$45.00	$45.00	$45.00	$45.00	$45.00	$45.00	$45.00	$45.00	$45.00
	Sales	$0	$1,320,000	$1,320,000	$1,320,000	$1,320,000	$1,320,000	$1,320,000	$1,320,000	$1,320,000	$1,320,000	$1,320,000	$13,200,000
Less:	Variable cost	$0	$540,000	$540,000	$540,000	$540,000	$540,000	$540,000	$540,000	$540,000	$540,000	$540,000	$5,400,000
Less:	Fixed cost	$0	$190,000	$190,000	$190,000	$190,000	$190,000	$190,000	$190,000	$190,000	$190,000	$190,000	$1,900,000
Less:	Depreciation	$0	$140,000	$140,000	$140,000	$140,000	$140,000	$140,000	$140,000	$140,000	$140,000	$140,000	$1,400,000
	Pre-tax cash flow	$0	$450,000	$450,000	$450,000	$450,000	$450,000	$450,000	$450,000	$450,000	$450,000	$450,000	$4,500,000
Less:	Taxes @31%	$0	$139,500	$139,500	$139,500	$139,500	$139,500	$139,500	$139,500	$139,500	$139,500	$139,500	$1,395,000
	After-tax cash flow	$0	$310,500	$310,500	$310,500	$310,500	$310,500	$310,500	$310,500	$310,500	$310,500	$310,500	$3,105,000
Add back:	Depreciation	$0	$140,000	$140,000	$140,000	$140,000	$140,000	$140,000	$140,000	$140,000	$140,000	$140,000	$1,400,000
Add back:	recovery of NWC	$0	$0	$0	$0	$0	$0	$0	$0	$0	$0	$70,000	$70,000
	annual net cash flows	-$1,470,000	$450,500	$450,500	$450,500	$450,500	$450,500	$450,500	$450,500	$450,500	$450,500	$520,500	$3,105,000
	NPV	$1,207,751.93

Calculations