Question

FastTrack​ Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is

$195,300

per year. Once in​ production, the bike is expected to make

$287,950

per year for

10

years. The cash inflows begin at the end of year 7.

For parts​ a-c, assume the cost of capital is

10.6%.

a. Calculate the NPV of this investment opportunity. Should the company make the​ investment?

b. Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.

c. How long must development last to change the​ decision?

For parts​ d-f, assume the cost of capital is

14.7%.

d. Calculate the NPV of this investment opportunity. Should the company make the​ investment?

e. How much must this cost of capital estimate deviate to change the​ decision?

f. How long must development last to change the​ decision?

Answer 1

1.
=-195300/10.6%*(1-1/1.106^6)+287950/10.6%*(1-1/1.106^10)*1/1.106^6
=106413.8784

2.
Accept the investment because NPV is equal to or greater than zero

3.
-195300/x*(1-1/(1+x)^6)+287950/x*(1-1/(1+x)^10)*1/(1+x)^6=0
=>IRR=12.3971%

Maximum deviation=12.3971%-10.6%=1.7971%

4.
-195300/10.6%*(1-1/1.106^x)+287950/10.6%*(1-1/1.106^10)*1/1.106^x=0

=>x=6.557323

5.
=-195300/14.7%*(1-1/1.147^6)+287950/14.7%*(1-1/1.147^10)*1/1.147^6
=-103146.6717

6.
Reject because NPV is less than zero

7.
-195300/x*(1-1/(1+x)^6)+287950/x*(1-1/(1+x)^10)*1/(1+x)^6=0
=>IRR=12.3971%

Maximum deviation=14.7%-12.3971%=2.3029%

8.
-195300/14.7%*(1-1/1.147^x)+287950/14.7%*(1-1/1.147^10)*1/1.147^x=0

=>x=5.410741

answered by: anonymous