Calculating project cash flows and NPV you are considering expanding your produc

Question

Calculating project cash flows and NPV you are considering expanding your product line that currently consists of skateboards to include gas-powered skateboards, and you feel you can sell 12,000 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 $80 each with variable costs of $25 for each one produced and annual fixed costs associated with production would be $170,000. In addition, there would be a $1,200,000 initial expenditure associated with the purchase of new production equipment. It is assumed that this initial expendirue will be depreciated using the simplified straight-line method down to zero over 10 years. The project will also require a one-time initial investment of $60,000 in net working capital associated with inventory, and this working capital investment will be recovered when the prjoect is shut down. Finally, assume that the firm's marginal tax rate is 36 percent.

a) What is initial cash outlay associated with this project? ___ ( received answer of 1260000)
b) what are 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 flows associated with termination of the project)?
d) What is the project's NPV given a required rate of return of 12 percent?

Explanation / Answer

a. The initial outlay includes the cost of the new machine as well as the investment in working capital here:
(NNN) NNN-NNNN+ 50000 =
1,050,000


b. Earnings before interest/taxes:

EBIT = 10000*(100-40) (sales - variable costs) - 160000 (fixed costs) - 100000 (depreciation)

EBIT = 600000 - 160000 - 100000 = 340000

After taxes, this results in net income = 340000(1-0.34) = 224400

Add back depreciation to this to find the annual free cash flow:

Annual free cash flows for years 1 through 9 = 224400 + 100000 = 324,400

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