FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Devel
ID: 2683923 • Letter: F
Question
FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development willtake six years and the cost is $200,000 per year. Once in production, the bike is expected to make
$300,000 per year for 10 years. Assume the cost of capital is 10%.
a. Calculate the NPV of this investment opportunity, assuming all cash flows occur at the end
of each year. Should the company make the investment?
b. By how much must the cost of capital estimate deviate to change the decision? (Hint: Use
Excel to calculate the IRR.)
c. What is the NPV of the investment if the cost of capital is 14%?
Explanation / Answer
Net present value (NPV) = Present value of cash inflows - Present value of cash outflows.
Question a). Solution :-
Present value of cash inflows = 300000 * [ 1 - (1 + 0.10)-10 ] / 0.10
= 300000 * [ 1 - (1.10)-10 ] / 0.10
= 300000 * [ 1 - 0.3855 ] / 0.10
= 300000 * 0.6145 / 0.10
= 300000 * 6.145
= $ 1843500.
Present value of cash outflows = 200000 * [ 1 - (1 + 0.10)-10 ] / 0.10
= 200000 * [ 1 - (1.10)-10 ] / 0.10
= 200000 * [ 1 - 0.3855 ] / 0.10
= 200000 * 0.6145 / 0.10
= 200000 * 6.145
= $ 1229000.
Accordingly, Net present value (NPV) = 1843500 - 1229000
= $ 614500.
Question c). Solution :- If the cost of capital is 14 % :-
Present value of cash inflows = 300000 * [ 1 - (1 + 0.14)-10 ] / 0.14
= 300000 * [ 1 - (1.14)-10 ] / 0.14
= 300000 * [ 1 - 0.2697 ] / 0.14
= 300000 * 0.7303 / 0.14
= 300000 * 5.216 (approx)
= $ 1564800.
Present value of cash outflows = 200000 * [ 1 - (1 + 0.14)-10 ] / 0.14
= 200000 * [ 1 - (1.14)-10 ] / 0.14
= 200000 * [ 1 - 0.2697 ] / 0.14
= 200000 * 0.7303 / 0.14
= 200000 * 5.216 (approx)
= $ 1043200.
Accordingly, Net present value (NPV) = 1564800 - 1043200
= $ 521600.
Conclusion :-
a). Net present value (NPV) if the cost of capital is 10 % :- $ 614500. c). Net present value (NPV) if the cost of capital is 14 % :- $ 521600.Related Questions
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