You are considering expanding your production line that currently consist of ska

Question

You are considering expanding your production line that currently consist of skateboards to include gas powered skateboard and you feel you can sell 11,000 of those per year for 10 years (after which time this project is expected to shut down with sollar- powered skateboards taking over. The gas skateboards will sell for $70 each with variable cost of $35 for each on produced, and annual fixed cost associated with production would be 140,000. In addition there would be a 1,400,000 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 over 10 years. This project will also require a one time initial investment of 80,000 in net working capital Investment will be recovered when the project is shut down. Finally assume that the firm's margine tax rate is 33 percent.

A) What is the initial cash outlay associated with this project.

B) What are the annual net cash flows associated with this project for years 1 through 9?

C) What is the terminal cash flow in year 10 (that is what is the free cash flow in year 10 plus any additional cash flow associated with terminiation of project.

D) What is the project's NPV given a required rate of return of 7 percent?

Explanation / Answer

a) Initial Cash Outlay = Purchase of New Production equipment + Net working capital investment

= 1400000+80000

= 1480000

b)

c)

b)

Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Sales 770000 770000 770000 770000 770000 770000 770000 770000 770000 Variable cost @ 35 -385000 385000 385000 385000 385000 385000 385000 385000 385000 Annual Fixed Cost -140000 140000 140000 140000 140000 140000 140000 140000 140000 Depreciation -140000 -140000 -140000 -140000 -140000 -140000 -140000 -140000 -140000 Net income before Tax 105000 1155000 1155000 1155000 1155000 1155000 1155000 1155000 1155000 Marginal Tax@33% 34650 381150 381150 381150 381150 381150 381150 381150 381150 Net income 70350 773850 773850 773850 773850 773850 773850 773850 773850 Add Depreciation 140000 140000 140000 140000 140000 140000 140000 140000 140000 Annual Net Cash Flows 210350 913850 913850 913850 913850 913850 913850 913850 913850

c)

Terminal Net Cash Flows Year 10 Sales 770000 Variable cost @ 35 385000 Annual Fixed Cost 140000 Depreciation -140000 Net income before Tax 1155000 Marginal Tax@33% 381150 Net Income 773850 Add : Depreciation 140000 Add : Net Working Capital investment Recovered 80000 Terminal Cash Flow 993850

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