You are considering new elliptical trainers and you feel you can sell 5,000 of t

Question

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 $1,000 each with variable costs of $500 for each one produced, while annual fixed costs associated with production would be $1,000,000. In
addition, there would be a $5,000,000 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 $1,000,000 in net working
capital associated with inventory, and it is assumed that this working capital investment
will be recovered when the project is shut down. Finally, assume that the firm

Explanation / Answer

a. The initial outlay includes the cost of the new machine as well as the investment in working capital here:
(NNN) NNN-NNNN+ 50000 =1,050,000

b. Earnings before interest/taxes:
EBIT = 10000*(100-40) (sales - variable costs) - 160000 (fixed costs) - 100000 (depreciation)

EBIT = 600000 - 160000 - 100000 = 340000

After taxes, this results in net income = 340000(1-0.34) = 224400

Add back depreciation to this to find the annual free cash flow:

Annual free cash flows for years 1 through 9 = 224400 + 100000 = 324,400

c) Terminal cash flow in year 10 will just be nearly the same as the annual year cash flow except they recover the 50000 initial working capital investment as the problem described so it will be:

324400+50000 = 374400

d)
NPV = All the cash flows discounted

I don't have a financial calculator with me that allows me to do NPV so I used a website and plugged the numbers in (-1050000 for initial cost, 324400 for the first 9 cash flows and 374400 for the last cash flow)

NPV = -1050000 + 324400/1.1 + 324400/(1.1^2) + ...+ 324400/(1.1^9) + 374400/(1.1^10) = 962574.73

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