Project Evaluation. Revenues generated by a new fad product are forecast as foll

Question

Project Evaluation. Revenues generated by a new fad product are forecast as follows:
Year Revenues
1 $40,000
2 30,000
3 20,000
4 10,000
Thereafter 0
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. (LO9-2)
a. What is the initial investment in the product? Remember working capital.
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?
c. If the opportunity cost of capital is 12%, what is project NPV?
d. What is project IRR?

Explanation / Answer

Step 1) Initial investment

Step 2) Depriciation

=Cost-salvage value/No of years

=45000/4 = 11,250$

Step 3) Statement showing WC needs in each year

Step 4) Statement showing NPV

IRR is the rate where NPV is 0

At 18.39% NPV is 0 Hence IRR is 18.39%

Particulars Amount Purchase price plant and equipment 45000 WC requirement (40000*20%) 8000 Initial investment 53000

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