Question

Revenues generated by a new fad product are forecast as follows:Year Revenues1 $54,000 2 30,000 3 20,000 4 10,000 Thereafter 0 Expenses are expected to be 50% of revenues, and working capital required in each year is expected to be 10% of revenues in the following year. The product requires an immediate investment of $50,000 in plant and equipment.a. What is the initial investment in the product? Remember working capital.Initial investment $ b. If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight-line depreciation, and the firm’s tax rate is 30%, what are the project cash flows in each year? Assume the plant and equipment are worthless at the end of 4 years. (Do not round intermediate calculations.)Year Cash Flow1 $ 2 3 4 c. If the opportunity cost of capital is 12%, what is the project's NPV? (A negative value should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)NPV $ d. What is project IRR? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)IRR %rev: 09_24_2015_QC_CS-26391, 02_03_2015_QC_C

Answer 1

Answer:

a. What is the initial investment in the product?

• $55,400

b. If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight-line depreciation, and the firm’s tax rate is 30%, what are the project cash flows in each year?

• NCF₁ = $25,050
• NCF₂ = $15,250
• NCF₃ = $11,750
• NCF₄ = $8,250

c. If the opportunity cost of capital is 12%, what is the project's NPV?

• -$7,270.28

d. What is project IRR?

• 4.27%

Explanation:

year     cash flows        costs            working capital            

0          -$50,000                                -$5,400

1            $54,000        -$27,000          $3,000 (+$2,400)

2           $30,000        -$15,000           $2,000 ($1,000)

3           $20,000        -$10,000            $1,000 (+$1,000)

4           $10,000         -$5,000             $0 (+$1,000)

net cash flow year 1 = [($54,000 - $27,000 - $12,500) x 0.7] + $12,500 + $2,400 = $25,050

net cash flow year 2 = [($30,000 - $15,000 - $12,500) x 0.7] + $12,500 + $1,000 = $15,250

net cash flow year 3 = [($20,000 - $10,000 - $12,500) x 0.7] + $12,500 + $1,000 = $11,750

net cash flow year 4 = [($10,000 - $5,000 - $12,500) x 0.7] + $12,500 + $1,000 = $8,250

I calculated the NPV and IRR using a financial calculator