FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Devel
ID: 2757898 • Letter: F
Question
FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the costs is $203,700 per year. Once in production, the bike is expected to make $293,712 per year for 10 years. The cash inflows begin at the end of year 7. For parts A-C, assume the cost of capital is 10.1%
a. Calculate the NPV of this investment opportunity. Should the company make the investment?
b.Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.
c. How long must development last to change the decision?
For parts d-f, assume the cost of capital is 13.9%
d. Calculate the NPV of this investment opportunity. Should the company make the investment
e. How much must this cost of capital estimate deviate to change the decision? The max deviation is _______%
f. How long must development last to change the decision? PLEASE CLEARLY STATE ANSWERS
Explanation / Answer
The Cash flow table is as shown below:
The NPV is calculated by using excel formula =npv(rate,cash_flows) where rate =0.101 or 10.1%
The IRR is also calculated using the IRR formula in excel. The results are tabulated below:
a. The NPV is $124,275.02 . The company should make the investment
b. IRR is 12.06%. In order to chnage the decision the deviation is cost of capital is between 10.1% and 12.05% = 1.95% (12.05-10.1) which is the maximum allowable deviation to leave the decesion unchnaged
c. If the development lasts for 7 years instead of 6 years, then the decesion must be chnagedas NPV becomes negative and IRR will lower than cost of capital and hence the project would be rejected
d. When the cost of capital is 13.9%, the NPV is as shown below:
d. NPV at 13.9% is -89,888.85 (negative) and the project should be rejected.
e. The maximum deviation in cost of capital is 13.9 -12.05 = 1.85% for the decesion to change
f. If the development lasts only for 5 years instead of 6, then the project becomes profitable.
Year Cash Flow 1 -203700 2 -203700 3 -203700 4 -203700 5 -203700 6 -203700 7 293712 8 293712 9 293712 10 293712 11 293712 12 293712 15 293712 16 293712 17 293712 18 293712 NPV at 10.1% $ 1,24,275.02 IRR 12.06%Related Questions
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