Revenues generated by a new product are forecast as follows: Year Revenue 1 $40,

Question

Revenues generated by a new product are forecast as follows: Year Revenue 1 $40,000 2 30,000 3 20,000 4 10,000 5 -0- no sales after year 4 Expenses are expected to be 40% of revenues, and working capital required in each year is expected to be 20% of revenues in the following year. The product requires an immediate investment of $45,000 in plant and equipment. A. What is the initial investment in the product, including working capital? B. If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight-line depreciation and the firm’s tax rate is 40%, what are the project cash flows in each year? C. If the opportunity cost of capital is 12%, what is the project NPV? Should the project be accepted or rejected?

Explanation / Answer

Solution A:

The initial investmment in project is th initial cost + working capital

= 45000 + 20% of 40000

= 45000 +8000 = $53000 is the initial investment

Solution B : cash flow :

Solution 3:

Since the Net present value is negative of the project hence the project should be rejected.

Thank you.

Particulars 0 1 2 3 4 5 Initial investment -45000 Revenue 40000 30000 20000 10000 0 Expenses 40% of revenue 16000 12000 8000 4000 0 Gross profit = sales - expense 24000 18000 12000 6000 0 Depreciation = 45000/5 9000 9000 9000 9000 9000 Profit before tax 15000 9000 3000 -3000 -9000 Tax rate40 % 6000 3600 1200 -1200 -3600 Profit after tax 9000 5400 1800 -1800 -5400 Cash flow = profit + dep 18000 14400 10800 7200 3600 Working capital -8000 -6000 -4000 -2000 0 0 Opening working capital 8000 6000 4000 2000 8000 Total cash flow -53000 20000 16400 12800 9200 11600

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