Question

Revenues generated by a new fad product are forecast as follows Revenues $50,000 20,000 10,000 5,e00 Year 1 2 3 Thereafter Expenses are expected to be 60 % of revenues, and working capital required in each year is expected to be 20 % of revenues in the following year. The product requires an immediate investment of $52,000 in plant and equipment a. What is the initial investment in the product? Remember working capital. ces Initial investment 62,000 b. If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight-line depreciation, and the firm's tax rate is 40 % , what are the project cash flows in each year? Assume the plant and equipment are worthless at the end of 4 years. (Do not round intermediate calculetions.)

Answer 1

a) Initial Investment is - Investment in Plant & Equipment + 20% of Year 1 revenues Initial Investment is = (52000+(50000*20%)) Initial Investment is = $ 62,000/. Year 2 20,000 (12,000) Year 3 10,000 (6,000) Year 4 5,000 (3,000) (13,000) (13,000) (5,000) (13,000) 9,000) b) Determination of Project cashflows in each year :- Particulars Year 1 Revenues 50,000 Less: Expenses 60% (30,000) Less: Depreciation (52000/4) (13,000) Profit before tax 7,000 Add/(Less): Tax 40% (2,800) Profit after tax 4,200 Add: Depreciation 13,000 Cashflow for each year 17,200 Less: Working capital 20% 4,000 Net cash flow for the year 13,200 2,000 (3,000) (11,000) 4,400 (6,600) 13,000 6,400 3,600 (5,400) 13,000 7,600 1,000 6,600 13,000 10,000 2,000 8,000 6,400

flows PVF @10% c) Determination of Net Present value @10% - Cash Present Year Value S (62,000) 1.00 (62,000.00) 13,200 0.91 12,000.00 8,000 6,611.57 6,600 0.75 4,958.68 6,400 0.68 4,371.29 NPV (34,058.47) 0.83 Net Present value at 10% is - $ 34,058.47/. d) IRR is the rate of return at which the Net presnet value of cashflows wil be ZERO. Using trial and error method IRR is determined as below:- Determination of IRR :- Cash PVF - Year flow S @22.3658% (62,000) 1.00 13,200 1.29 8,000 1.66 6,600 2.14 6,400 2.75 Present Value S (62,000.00) 17,002.82 13,273.45 14,105.38 17,618.45 0.09 NPV IRR is - 22.37% Rounded to two decimals