You and your friends are thinking about starting a motorcycle company named Appl
ID: 2744499 • Letter: Y
Question
You and your friends are thinking about starting a motorcycle company named Apple Valley Choppers. Your initial investment would be $500,000 for depreciable equipment, which should last 5 years, and your tax rate would be 40%. You could sell a chopper for $10,000, assuming your average variable cost per chopper is $3000, and assuming fixed costs, such as rent, utilities and salaries, would be $200,000 per year.
If you could sell 60 choppers in the first year, and your sales volume increased by 5% each year until the end of year 5, what would the net present value be at a 15% discount rate? I have a table that shows the answers but how are they found?
If you need to invest working capital equal to 10% of the next (coming) year‘s sales revenue, what would be the effect on the net present value of the project? Do you think that working capital investments always reduce the net present value of projects? (Assume a 15% discount rate, and sales volume increases by 5% each year.)
Explanation / Answer
Calculation of Net present value at a discount rate of 15%:
Year
Cash flows
Discount factor @ 15%
Present value = cash flow * discount factor
1
172,000
1 / (1+15%)1 = 0.8695
149,554
2
184,600
1 / (1+15%)2 = 0.7561
139,576.06
3
1 / (1+15%)3 = 0.6575
129,659
4
209,800
1 / (1+15%)4 = 0.5717
119,942.66
5
226,000
1 / (1+15%)5 = 0.4972
112,367.20
Net present value = sum of all present value of cash flows
151,098.92
Note: Cash flows from year 1 - 6:
Year - 1:
2. If we need to invest working capital equal to 10% of the next (coming) year‘s sales revenue, Computation of the effect on the net present value of the project:
Net present value = 647,882.74 - $500,000 = $147,82.74
The inclusion of working capital means that net present value would decrease.
Year
Cash flows
Discount factor @ 15%
Present value = cash flow * discount factor
0 -$500,000 1 -$500,0001
172,000
1 / (1+15%)1 = 0.8695
149,554
2
184,600
1 / (1+15%)2 = 0.7561
139,576.06
3
197,2001 / (1+15%)3 = 0.6575
129,659
4
209,800
1 / (1+15%)4 = 0.5717
119,942.66
5
226,000
1 / (1+15%)5 = 0.4972
112,367.20
Net present value = sum of all present value of cash flows
151,098.92
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