You have developed a new a new recreational tennis racket with tennis great Jimm

Question

You have developed a new a new recreational tennis racket with tennis great Jimmy Connors. You have paid Jimmy Connors for his involvement in the project $250,000. The racket is state of the art and guaranteed to correct any backhand. You now need to decide if you want to proceed with mass marketing of this racket. You estimate the sales price of the new racket to be $400 per racket and sales volume to be 1,000 units in year 1, 1,250 units in year 2; and 1,325 units in year 3. The project has a three year life. Variable costs amount to $225 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $165,000 in assets which will be depreciated straight line to zero over the three year project life. The actual market value of these assets at the end of year three is expected to be $35,000. NWC requirements at the beginning of each year will be 20 percent of the projected sales during the coming year. The tax rate is 34 percent and the required return on the project is 10 percent.

A. What will the annual incremental cash flows for the project be?

B. Using NPV analysis should the project be undertaken? Explain.

Explanation / Answer

A. What will the annual incremental cash flows for the project be? Year-1 1000 Units B. Using NPV analysis should the project be undertaken? Explain. Amount Sales (400Per units) $      400,000 Cash paid to Jimmy Connors 250000 Variable Cost (225 Per unit) $     (225,000) Initial investment 165000 Fixed Cost $     (100,000) Total investment in project -415000 NWC Total cash flow at year 1 $        75,000 Year-2 1125 Units Investment -415000 Cash inflow for first year 75000 Sales (400Per units) $      450,000 Cash inflow for Second year 96875 Variable Cost (225 Per unit) $     (253,125) Cash inflow for thried year 153204 Fixed Cost $     (100,000) NPV -89921 Total cash flow at year 2 $        96,875 1325 Units We can reject the project as NPV is negitive Year-3 Sales (400Per units) $      530,000 Variable Cost (225 Per unit) $     (298,125) Working Capital change well not effect the NPV. As, at the beging of the month we put the working capital and withdow the capital end of the year because we are not considering the time value of the money Fixed Cost $     (100,000) Amount received from sales of assests $        35,000 Income tax -13671 Total cash flow at year 3 $      153,204 Wn-1 1325 Units Year-3 Sales (400Per units) $      530,000 Variable Cost (225 Per unit) $     (298,125) $      231,875 Fixed Cost $     (100,000) Depresiation $       (43,333) 165000-35000/3 Amount paid to Jimmy Connors $       (83,333) 250000/3 Amount received from sales of assests $        35,000 Total cash inflow at year 3 $        40,208 income Tax $ (13,670.83)

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