Revenues generated by a new fad product are forecast as follows: Year Revenues 1

Question

Revenues generated by a new fad product are forecast as follows:

Year Revenues

1 $45,000

2 $40,000

3 $30,000

4 $20,000

Thereafter $0

Expenses are expected to be 40% of revenues, and working capital required in each year is expected to be 30% of revenues in the following year. The product requires an immediate investment of $50,000 in plant and equipment.

a. What is the initial investment in the product? Remember working capital.

Initial investment $________

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? (Enter your answers in thousands of dollars. Do not round intermediate calculations. Round your answers to 2 decimal places.)

Year Cash Flow

1 $_______

2 $_______

3 $_______

4 $_______

c. If the opportunity cost of capital is 15%, what is project NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

NPV $______

d. What is project IRR? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

IRR ______%

Explanation / Answer

Answer:a The total initial investment (I) is the sum of the invest in plant and equipment (in this case $50,000) plus the initial Working Capital required (in this case is the 30% of the Revenues of Year 1 = 0.30*$45,000 = $13500):

I = $50,000 + $13,500 = $63,500

Answer:b

Answer:c

NPV is negative.

Answer:d IRR:

Discount rate 15% Intial investment -63500 22700 22400 18800 18200 NPV -4056.037178

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