FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Devel

Question

FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the costs is $296,638 per year. Once in production, the bike is expected to make $202,100 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 10.9%

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 14.7%

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?

f. How long must development last to change the decision?

Explanation / Answer

Solution :

The present value of cash inflows = $ 202,100/(1+0.109)7 +   $ 202,100/(1+0.109)8 + $ 202,100/(1+0.109)9 + $ 202,100/(1+0.109)10 + $ 202,100/(1+0.109)11 + $ 202,100/(1+0.109)12 + $ 202,100/(1+0.109)13 + $ 202,100/(1+0.109)14 + $ 202,100/(1+0.109)15 + $ 202,100/(1+0.109)16 + $ 202,100/(1+0.109)17

The present value of cash inflows = $677,291.13

Net present value = - $ 1,779,828 + $677,291.13

Net present value = - $ 1,102,536.87

b) To calculate the Internal rate of return :

Annuity = $2,223,100 / 10

Annuity = $ 222,310

Payback period = $ 1,779,828 / $ 222,310

Payback period = 8 .006 years

For the present value of annuity table , for n = 10 years the value closest to 8.00 is 4 %

Choosing a discount factor of 4%

At r = 4%

The net present value =- $380,582.18

By choosing r = 2%

NPV = - $23,489.88

By choosing r = 1%

NPV = $194,037.19

IRR =   1% + ($1,973,865.19   - $1,779,828) /( $1,973,865.19 - $1,756,338.12 )

IRR = 1%+ 194037.19 / 217,527.07

IRR = 1 % + 0.8920

IRR = 1.8920 %

Year Cash outflows Cash Inflows 1 $296,638 $0.00 2 $364,829.44 $0.00 3 $497,604.75 $0.00 4 $752,680.56 $0.00 5 $1,262,607.69 $0.00 6 $2,348,863.11 $0.00 7 $0.00 $202,100 8 $0.00 $202,100 9 $0.00 $202,100 10 $0.00 $202,100 11 $0.00 $202,100 12 $0.00 $202,100 13 $0.00 $202,100 14 $0.00 $202,100 15 $0.00 $202,100 16 $0.00 $202,100 17 $0.00 $202,100

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