Revenues generated by a new fad product are forecast as follows: Year Revenues 1

Question

Revenues generated by a new fad product are forecast as follows: Year Revenues 1 $52,000 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 30% of revenues in the following year. The product requires an immediate investment of $54,000 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

Explanation / Answer

Using the formula provided there, the payback period for this project is 2500/600=4.16 years. Since the firm accepts projects with payback periods of less than 5 years, the project wil be accepted. In ordert ofind whether it shoud be pursued at a 2% disocunt rate, we find its present value using the same formula as in the previous question. PV = -2500 + 600*[1 - (1+0.02)^(-6)]/0.02 PV = -2500 + 3360.85 PV = 860.85 Since PV>0, the project should be pursued if the discount rate is 2%. If the discount rate is 12%: PV = -2500 + 600*[1 - (1+0.12)^(-6)]/0.12 PV = -2500 + 2466.84 PV = -33.15 Since PV

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