Question

Please provide a step by step solution to each question. No excel or table answer. I want to understand how you solved each step please.

A company is considering manufacturing new elliptical trainers. This company did a marketing research 2 years ago, paying $750,000 consulting fees and found that the market is ripe for such a new product. The company feels that they can sell 5,000 of these per year for 5 years (after which time this project is expected to shut down). The elliptical trainers would sell for $ 2,000 each and have a variable cost of $500 each. The annual fixed costs associated with production would be $1,000,000. In addition, there would be a $5,000,000 initial expenditure associated with the purchase of new production equipment. It is assumed that this initial expenditure will be depreciated using the straight- line method down to zero over 5 years. This project will also require a one- time initial investment of $1,000,000 in working capital associated with inventory. The introduction of this new elliptical trainer will reduce the sales of an existing training machine that the company currently sells. The company estimates that $250,000 per year before tax basis will be lost on this existing training machine if the new elliptical trainer is introduced. At the end of the 5th year, the company estimates selling the production equipment for $150,000. Finally, assume that the firm’s marginal tax rate is 34 percent.

a) What is the initial outlay associated with this project?

b) What are the annual after- tax operating cash flows associated with this project for years 1 through 4?

c) What is the non-operating cash flow in year 5 or the terminal value?

d) What is the project’s NPV given a 10 percent cost of capital?

Answer 1

A. Initial Investment of this Project is 7,50,000.

B.

	Particular		Amount
	Sales	5,000 * $ 2,000	10000000
Less:	Variable cost	5000 * $500	2500000
	Contribution		7500000
Less:	Fixed Cost		10,00,000
Less:	Initial Expenditiure For year 1		10,00,000
Less:	One time Initial Investment		10,00,000
Less:	Loss on existing Training Machine		2,50,000
Less:	Initial Investment		7,50,000
	Cash flow at the year 1		$35,00,000

C.

	Particular	Amount
	Sales of 5th year	10000000
Less:	Variable cost	2500000
	Contribution	7500000
Less:	Fixed Cost	10,00,000
Less:	Initial Expenditiure For year 5 (Depreciation)	10,00,000
Less:	Loss on existing Training Machine	2,50,000
Add:	Sale of equipment	1,50,000
	Cash flow at the year 1	54,00,000
Less:	Tax	1836000
	Cash flow after tax	35,64,000

Thanks