You are considering expanding your product line that currently consists of skate

Question

You are considering expanding your product line that currently consists of skateboards to include gas-powered skateboards, and you feel you can sell 9.000 of these per year for 10 years (after which time this project is expected to shut down with solar-powered skateboards taking over) The gas skateboards would sell for $ 120 each with variable costs of S50 for each one produced, and annual fixed costs associated with production would be S190.000 In addition, there would be $1,300,000 initial expenditure associated with the purchase of new production equipment It is assumed that this initial expenditure will be depreciated using the simplified straight-line method down to zero ova 10 years The project will also require a one-time initial investment of $30,000 in net working capital associated with inventory, and this working capital investment will be recovered when the project is shut down Finally, assume that the firm's marginal tax rate is 38 patent What is the initial cash outlay associated with this project? What are the annual net cash flows associated with this project for years 1 through 9? What is the terminal cash flow in year 10 (that is. what is the free cash flow in year 10 plus any additional cash flows associated with termination of the project)? What is the project's NPV given a required rate of return of 11 percent?

Explanation / Answer

a. Total Cash Outlay = $1,330,000

b. Annual cash flows from year 1 to 9 = $322,200

c. Terminal cash flow in year 10 = $352,200 (322,200 + 30,000)

d. NPV = $578,076

Particulars 0 1 2 3 4 5 6 7 8 9 10 Contribution - $630,000 $630,000 $630,000 $630,000 $630,000 $630,000 $630,000 $630,000 $630,000 $630,000 Less: Fixed Cost - -$190,000 -$190,000 -$190,000 -$190,000 -$190,000 -$190,000 -$190,000 -$190,000 -$190,000 -$190,000 Less: Depreciation - -$130,000 -$130,000 -$130,000 -$130,000 -$130,000 -$130,000 -$130,000 -$130,000 -$130,000 -$130,000 Profit - $310,000 $310,000 $310,000 $310,000 $310,000 $310,000 $310,000 $310,000 $310,000 $310,000 Less: Taxes @ 38% - -$117,800 -$117,800 -$117,800 -$117,800 -$117,800 -$117,800 -$117,800 -$117,800 -$117,800 -$117,800 Profit after tax - $192,200 $192,200 $192,200 $192,200 $192,200 $192,200 $192,200 $192,200 $192,200 $192,200 Add: Depreciation - $130,000 $130,000 $130,000 $130,000 $130,000 $130,000 $130,000 $130,000 $130,000 $130,000 Cash flow after depreciation - $322,200 $322,200 $322,200 $322,200 $322,200 $322,200 $322,200 $322,200 $322,200 $322,200 Initial cash outlay -$1,300,000 - - - - - - - - - - Working Capital required -$30,000 - - - - - - - - - - Working capital release - - - - - - - - - - $30,000 Total Cash Flows -$1,330,000 $322,200 $322,200 $322,200 $322,200 $322,200 $322,200 $322,200 $322,200 $322,200 $352,200 NPV PVF @ 11% 1.000 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 Present Value -$1,330,000 $290,270 $261,505 $235,590 $212,243 $191,210 $172,261 $155,190 $139,811 $125,956 $124,039 $578,076

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