Question

Pointless Luxuries Inc. (PLI) produces unusual gifts targeted at wealthy consumers. The company is analyzing the introduction of a new device designed to attach to the collar of a cat or dog. The product contains a GPS, an audible that can be triggered remotely, and an automatic emergency K-911 number that is called if the animal is injured. PLI estimates that developing this product will require up-front capital expenditures of $10 million, costs that will be depreciated on a straight-line basis to zero over five years. However, PLI estimates they could sell the equipment at the end of five years for $3,000,000. The project would use an existing warehouse that you own that is currently rented out to a neighboring firm. Next year’s rental charge on the warehouse is $200,000 and the rent is expected to grow at 4% a year. PLI believes that it can sell the product initially for $170. The selling price will increase to $190 in years 2 and 3 before falling to $170 and $150 in years 4 and 5, respectively. After five years the company will withdraw the product from the market and replace it with something else. Variable costs are $75 in year 1 and increase at an annual rate of 10%. PLI forecasts volume of 25,000 units the first year with subsequent increases of 25% (year 2), 20% (year 3), 20% (year 4), and 15% (year 5). Offering this product will force PLI to make additional investments in receivables and inventory. Projected end-of-year balances appear in the following table. Year 0 1 2 3 4 5 Accounts Receivable $0 $100,000 $150,000 $200,000 $100,000 $0 Inventory $0 $300,000 $350,000 $400,000 $200,000 $0 The firm faces a tax rate of 34%. a. Calculate the project’s cash flows each year. b. Calculate the NPV assuming a 10% opportunity cost of capital. What is the cost of capital is 15%? c. What is the IRR of the investment?

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Cell reference -

Hope this will help, please do comment if you need any further explanation. Your feedback would be appreciated.