FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $201,800 per year. Once in production, the bike is expected to make $299,260 per year for 10 years. The cash inflows begin at the end of year 7.For parts a-b, assume the cost of capital is 9.2%.
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. For part c, assume the cost of capital is 14.1%.
c. Calculate the NPV of this investment opportunity. Should the company make the investment?
a. Calculate the NPV of this investment opportunity.
If the cost of capital is 9.2%, the NPV is $_____. (Round to the nearest dollar.)
Should the company make this investment? (Select the best choice below.)
A. Reject the investment because the NPV is less than zero ($0).
B. Accept the investment because the NPV is equal to or less than zero ($0).
C. Reject the investment because the NPV is equal to or greater than zero ($0).
D. Accept the investment because the NPV is equal to or greater than zero ($0).
b. Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.
The IRR is ____%.(Round to two decimal places.)
If the cost of capital is 9.2%, the maximum deviation is ____%. (Round to two decimal places.)
c. Calculate the NPV of this investment opportunity. Should the company make the investment?
If the cost of capital is 14.1%, the NPV is $____. (Round to the nearest dollar.)
Should the company make the investment? (Select the best choice below.)
A. Reject the investment because the NPV is equal to or greater than zero ($0).
B. Accept the investment because the NPV is equal to or greater than zero ($0).
C. Accept the investment because the NPV is equal to or less than zero ($0).
D. Reject the investment because the NPV is less than zero ($0).
1.
If the cost of capital is 9.2%, the NPV is
=-201800/9.2%*(1-1/1.092^6)+299260/9.2%*(1-1/1.092^10)*1/1.092^6
=222844.7101
2.
Should the company make this investment?
Accept the investment because the NPV is equal to or greater than
zero ($0)
3.
The IRR is
-201800/x*(1-1/(1+x)^6)+299260/x*(1-1/(1+x)^10)*1/(1+x)^6=0
=>IRR=x=12.4851%
4.
If the cost of capital is 9.2%, the maximum deviation is
Maximum deviation=12.4851%-9.2%=3.2851%
3.
If the cost of capital is 14.1%, the NPV is
=-201800/14.1%*(1-1/1.141^6)+299260/14.1%*(1-1/1.141^10)*1/1.141^6
=-77913.4731
4.
Reject the investment because the NPV is less than zero ($0)
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