(Calculating free cash flows) You are considering new elliptical trainers and yo

Question

(Calculating free cash flows) You are considering new elliptical trainers and you feel you can sell 5,000 of these per year for 5 years (after which time this project is expected to shut down when it is learned that being fit is unhealthy). The elliptical trainers would sell for $1,800 each and have a variable cost of $900 each. The annual fixed costs associated with production would be $1,500,000. In addition, there would be a $4,000,000 initial expenditure associated with the purchase of new production equipment. It is assumed that this initial expenditure will be depreciated using the simplified straight-line method down to zero over 5 years. This project will also require a one-time initial investment of $1,400,000 in net working capital associated with inventory, and that working capital investment will be recovered when the project is shut down. Finally, assume that the firm's marginal tax rate is 31 percent. a. What is the initial outlay associated with this project? b. What are the annual free cash flows associated with this project for years 1 through 4? c. What is the terminal cash flow in year 5 (that is, what is the free cash flow in year 5 plus any additional cash flows associated with the termination of the project)? d. What is the project's NPV given a required rate of return of 11 percent?

Explanation / Answer

As per the given information, please see the projected Free Cash Flow statement below:

Solutions:

a) Initial Outlay assoicated with the project is -5,400,000 as can be observed from FCF of Year 0 in the table above

b) Annual cash flows for Year 1 to 4 are 2,318,000 each - please refer table for calculation

c) Terminal year cash flow in year 5 is 3,718,000 (Also add working capital release in final year - refer table)

d) To find the NPV given a required return of 11% , we first sum the discounted value of each year's cash flow and then subtract the initial outflow to find the NPV (please refer NPV calculation in table). As per the same, NPV = 3,997,921.15

Year 0 1 2 3 4 5 Revenue                9,000,000                    9,000,000                9,000,000                    9,000,000              9,000,000 Variable Cost             (4,500,000)                 (4,500,000)             (4,500,000)                  (4,500,000)            (4,500,000) Fixed Cost             (1,500,000)                 (1,500,000)             (1,500,000)                  (1,500,000)            (1,500,000) EBITDA                3,000,000                    3,000,000                3,000,000                    3,000,000              3,000,000 Depreciation                 (800,000)                     (800,000)                 (800,000)                      (800,000)               (800,000) PBT                2,200,000                    2,200,000                2,200,000                    2,200,000              2,200,000 Tax                 (682,000)                     (682,000)                 (682,000)                      (682,000)               (682,000) PAT                1,518,000                    1,518,000                1,518,000                    1,518,000              1,518,000 Dep                   800,000                       800,000                   800,000                        800,000                  800,000 Initial Working Capital     (1,400,000) Working Capital Release              1,400,000 Initial Capital Expenditure     (4,000,000) Free Cash Flow (C.F) -5400000 2318000 2318000 2318000 2318000 3718000 Present Value (PV) @ 11% -5400000.00 2088288.29 1881340.80 1694901.62 1526938.40 2206452.04 Initial C.F Annual C.F-1 Annual C.F-2 Annual C.F-3 Annual C.F-4 Terminal C.F

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