Question

(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 8 comma 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 ​$50 for each one​ produced, and annual fixed costs associated with production would be ​$200,000. 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 $ 40,000 in net 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? Ans: 1440000

b.  What are the annual net cash flows associated with this project for years 1 through 9​?

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 13 percent​?

Answer 1

A) Initial cash outlay = Purchase of equipment + Initial investment in net working capital = 1400000 + 40000 = 1440000

b) Net annual cash flow = [(Contribution pu * sales quantity) - Fixed cost - Depreciation) (1- tax )] + Depreciation

Depreciation is added back as it is non cash expense

= [(110-50)(8000) - 200000 - (1400000/10) ] [1-0.31] + (1400000/10)

=[480000 - 200000 - 140000] [0.69] + 140000

=140000(0.69) + 140000

=96600 + 140000 = 236600

C) Cash flow in Year 10 = Net annual cash flow + Net working capital

= [ 236600 + 40000 ] = 276600

D) PV of cash inflow = 236600 for 9 years @ 13% discounted + PV of Yr 10 cashflow of 276600 @ 13%

= 236600 * 5.1317 + 276600 * 0.294

=   1214160 + 81483 = 1295643