FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Devel
ID: 2643145 • Letter: F
Question
FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the costs is $196,900 per year. Once in production, the bike is expected to make $291,055 per year for 10 years. The cash inflows begin at the end of year 7.
For parts A-C, assume the cost of capital is 10.4%
a. Calculate the NPV of this investment opportunity. Should the company make the investment?
b.Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.
c. How long must development last to change the decision?
For parts d-f, assume the cost of capital is 14.7%
d. Calculate the NPV of this investment opportunity. Should the company make the investment
e. How much must this cost of capital estimate deviate to change the decision?
f. How long must development last to change the decision?
Explanation / Answer
NPV will be calculated as follows:
First of all we have to calculate the present value of all cash outflows = c*((1+i)^-n)-1)/i
Where i = rate of interest and n = number of periods and c is the same cashflow every year
= -196,900*((1+.104)^-6)-1)/.104
=-196,900*4.30 = -847,591
Present vaule of cash inflows will be
= 291,055*((1+.104)^-10)-1)/.104
= 291,055*6.04 = 1,758,084.43
This is the present value at 7 year, so we have to discount it so that we can have the present value at year 0
=1,758,084.43/(1+.104)^7 = 879,541.3
NPV = 879,541.3-847,591 = 31,950.
So, the company can accept the project.
The IRR in this case will be 12.4%, So maximum deviation allowable in the cost of capital is 2% (12.4%-10.4%) estimate to leave the decision unchanged.
If the development will last for 7 years the NPV will be negative, so the decision would change as NPV is negative now.
Part D,E&F
NPV will be calculated as follows:
First of all we have to calculate the present value of all cash outflows = c*((1+i)^-n)-1)/i
Where i = rate of interest and n = number of periods and c is the same cashflow every year
= -196,900*((1+.147)^-6)-1)/.147
=-196,900*3.82 = -751,224
Present vaule of cash inflows will be
= 291,055*((1+.147)^-10)-1)/.147
= 291,055*5.08 = 1,477,596.16
This is the present value at 7 year, so we have to discount it so that we can have the present value at year 0
=1,477,596.16/(1+.147)^7 = 565,733
NPV = 565,733-751,224 = -185,491.
So, the company cannot accept the project as NPV is negative.
The IRR in this case will be 12.4%, The cost of capital should be decreased by 2.26% (14.7%-12.4%) to change the decision.
If the development will last for 4 years instead of 6 years the NPV will be positive, so the decision would change.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.