Question

FastTrack​ Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $196,100 per year. Once in​ production, the bike is expected to make $287,713 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 9.9 %

.a. Calculate the NPV of this investment opportunity.________ (Round to the nearest​ dollar.) 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 is14.5 %

.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

Initial Cost Per year from Year1 to Year 6 = $196,100

Cash Inflow per year from Year 7 to Year 17 = $287,713

Discount Rate = 9.90%

1.

NPV = $151,127.72

2.

IRR is the discount rate at which NPV = 0,

Using trial and error method,

IRR = 12.323%

3.

If cost of capital = 14.50%

NPV = -$99,035.86

4.

If cost of capital exceeds IRR then project should not be taken,

For project to be taken cost of capital should decrease by, (14.50 - 12.323) = 2.177%

5.

If project development last for 5 year NPV = $82,703.94

which will change the decision,

So if Project development lasts for 5 years, it will change the decision