Consider the following for an 8 year special revenue generating project. (this i

Question

Consider the following for an 8 year special revenue generating project.   (this is the base case)

Sales revenue $250,000 in the first year and will increase by 20% per year for the next 4 years. In year 6 the revenue will decrease by 15% a year through year 8. There is no expected cash flow after 8 years as this venture has a constrained timeline and no expected value after 8 years.

Costs of goods sold will be 70% of sales.

Advertising and administrative expenses will be fixed at $10,000 per year.

Equipment will be purchased for $300,000 and will be depreciated using the 7 year MACRS asset class depreciation schedule.   Salvage value is expected to be $25,000

Working capital investment in year 0 is estimated to be $20,000 and is expected to be recovered in the final year of the project.  

Cost of Capital is 8% and Tax Rate is 30%.

A: Base Case scenario

Calculate the project’s NPV

What is your recommendation?

B: Pessimistic View

What is the impact on NPV based on pessimistic assumptions (consider both at the same time):

If Sales Revenue in the first year was only $150,000 and only increase by 10% for the next 4 years and then decline by 20% a year through year 8?

If Cost of Goods Sold were 75% of sales?

Explanation / Answer

Calculation of NPV

As the project is having positive NPV the project should be accepted

Year1 2 3 4 5 6 7 8 Sales 250000 250000*120%=300000 300000*120%=360000 360000*120%=432000 432000*120%=518400 518400*85%=440640 440640*85%=374544 374544*85%=318362 Less COGS 70%*Sales (175000) (210000) (252000) (302400) (362800) (308448) 262180 222853 Advertising (10000) (10000) (10000) (10000) (10000) (10000) (10000) (10000) Savings in tax due to dep300000-25000=275000 11789 20204 14430 10304 7367 7359 7367 3680 20000+25000 Net 76789 100204 112430 129904 152967 129551 109731 134189 PVAF .926 .857 .793 .735 .680 .630 .583 .540 71107 85875 89157 95479 104017 81617 63973 72462 Total 663687-320000=343687

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