Revenues generated by a new fad product are forecast as follows: Expenses are ex
ID: 2764813 • Letter: R
Question
Revenues generated by a new fad product are forecast as follows: 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. What is the initial investment in the product? Remember working capital. 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 1 decimal place.) If the opportunity cost of capital is 12%. 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.) What is project IRR? (Do not round intermediate calculations. Round your answer to 2 decimal places.)Explanation / Answer
a. The Initial investment shall be,
Investment in Plant & Equioment + Working Capital Requirements
i.e. $ 45,000 + 20% of $30,000 (revenue of 2nd Year)
Hence, $51,000
b. Project after tax Cash Flows:
Year
0
1
2
3
4
Revenues
-
$ 40,000.00
$ 30,000.00
$ 20,000.00
$ 10,000.00
Expenses @ 40%
-
$ 16,000.00
$ 12,000.00
$ 8,000.00
$ 4,000.00
Depreciation
-
$ 11,250.00
$ 11,250.00
$ 11,250.00
$ 11,250.00
Net Profit before taxes
-
$ 12,750.00
$ 6,750.00
$ 750.00
$ -5,250.00
Tax @ 40%
-
$ 5,100.00
$ 2,700.00
$ 300.00
$ -
Net Profit after taxes
-
$ 7,650.00
$ 4,050.00
$ 450.00
$ -5,250.00
Depreciation
-
$ 11,250.00
$ 11,250.00
$ 11,250.00
$ 11,250.00
Changes in Working Capital
$ -6,000.00
$ 2,000.00
$ 2,000.00
$ 2,000.00
$ -
Cash Flow after taxes
$ -6,000.00
$ 20,900.00
$ 17,300.00
$ 13,700.00
$ 6,000.00
c. Project NPV
Cash Flow after taxes
$ -6,000.00
$ 20,900.00
$ 17,300.00
$ 13,700.00
$ 6,000.00
Intial Investment
$-45,000.00
$ -
$ -
$ -
$ -
Discounting Factor @ 12%
1.00
$ 0.89286
$ 0.79719
$ 0.71178
$ 0.63552
NPV
$-51,000.00
$ 18,660.71
$ 13,791.45
$ 9,751.39
$ 3,813.11
Project NPV = $-4,983.33
d. Project IRR
The Internal Rate of Return (IRR) on a project is the rate of return at which the projects NPV equals zero. At this point, a project's cash flows are equal to the project's costs.
IRR is calculated using the NPV formula by solving for R if the NPV equals zero.
NPV= {Period Cash Flow / (1+R)^T} - Initial Investment
Cash Flows
$-51,000.00
$ 20,900.00
$ 17,300.00
$ 13,700.00
$ 6,000.00
IRR = 6.38%
Year
0
1
2
3
4
Revenues
-
$ 40,000.00
$ 30,000.00
$ 20,000.00
$ 10,000.00
Expenses @ 40%
-
$ 16,000.00
$ 12,000.00
$ 8,000.00
$ 4,000.00
Depreciation
-
$ 11,250.00
$ 11,250.00
$ 11,250.00
$ 11,250.00
Net Profit before taxes
-
$ 12,750.00
$ 6,750.00
$ 750.00
$ -5,250.00
Tax @ 40%
-
$ 5,100.00
$ 2,700.00
$ 300.00
$ -
Net Profit after taxes
-
$ 7,650.00
$ 4,050.00
$ 450.00
$ -5,250.00
Depreciation
-
$ 11,250.00
$ 11,250.00
$ 11,250.00
$ 11,250.00
Changes in Working Capital
$ -6,000.00
$ 2,000.00
$ 2,000.00
$ 2,000.00
$ -
Cash Flow after taxes
$ -6,000.00
$ 20,900.00
$ 17,300.00
$ 13,700.00
$ 6,000.00
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