Question

Problem # 1 Consider the following for an 8 year special revenue generating project.   (this is...

Problem # 1

Consider the following for an 8 year special revenue generating project.   (this is the base case)

  • Sales revenue $250,000 in the first year and will increase by 20% per year for the next 4 years. In year 6 the revenue will decrease by 15% a year through year 8. There is no expected cash flow after 8 years as this venture has a constrained timeline and no expected value after 8 years.
  • Costs of goods sold will be 70% of sales.
  • Advertising and administrative expenses will be fixed at $10,000 per year.
  • Equipment will be purchased for $300,000 and will be depreciated using the 7 year MACRS asset class depreciation schedule.   Salvage value is expected to be $25,000
  • Working capital investment in year 0 is estimated to be $20,000 and is expected to be recovered in the final year of the project.  

Cost of Capital is 8% and Tax Rate is 30%.

A: Base Case scenario

  • Calculate the project’s NPV
  • What is your recommendation?

B: Pessimistic View

  • What is the impact on NPV based on pessimistic assumptions (consider both at the same time):
    • If Sales Revenue in the first year was only $150,000 and only increase by 10% for the next 4 years and then decline by 20% a year through year 8?
    • If Cost of Goods Sold were 75% of sales?

Problem #2

Company needs to decide between two machines.

Machine A costs 10,000 and produce after tax cash flows of 3,000 per year for 5 years. No salvage.

Machine B costs 18,000 and produce after tax cash flows of 2,800 per year for 10 years. No salvage.

Discount rate is 8%

Which machine would you recommend?

Problem #3

Company needs to decide between two machines.

Machine C costs 10,000 and produce after tax cash flows of 4,000 per year for 3 years. No salvage.

Machine D costs 14,000 and produce after tax cash flows of 3,000 per year for 7 years. No salvage.

Discount rate is 8%

Which machine would you recommend?

Problem #4

Calculate NPV, Payback, Discounted Payback, IRR and Modified IRR for the following project

Initial Investment: -100,000

Annual project cash flow 22,000 for 6 years

Cost of capital is 6%

Homework Answers

Answer #1

You have asked 4 unrelated questions in a single post. Further your q - 1 has multiple sub parts. I will address all the sub parts of the first question. Please post the balance questions separately, one by one.

Q - 1

Part A: Base Case Scenario

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. The last row highlighted in yellow is your answer. Figures in parenthesis, if any, mean negative values. All financials are in $. Adjacent cells in blue contain the formula in excel I have used to get the final output.

Project's NPV is $  172,720

Recommendation: Since the project has positive NPV, this project should be accepted and undertaken by the company.

Part - B: Pessimistic View

Impact on NPV: NPV turns negative.

Impact on recommendation: The project is no longer viable and hence should be rejected.

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