You are considering expanding your product line that currently consists of skate

Question

You are considering expanding your product line that currently consists of skateboards to include gas-powered skateboards, and you feel
you can sell 8,000 of these per year for 10 years (after which time this project is expected to shut down with solar-powered
skateboards taking over). The gas skateboards would sell for $110 each with variable costs of $25 for each one produced,
while annual fixed costs associated with production $200,000. In addition, there would be a $1,400,000 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 10 years. This project wil also require a one-time initial investment of $70,000 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 32 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 9?
c. What is the terminal cash flow in year 10 (that is, what is the free cash flow in year 10 plus and additional cash flows
associated with termination of the project?
d. What is the project's NPV given a 8 percent required rate of return?

Explanation / Answer

a. What is the initial outlay associated with this project?

Initial outlay = -Initial Capital Expenditure + Net Working Capital

=$(-1400000+70000)

=$(1330000)

b) What are the annual free cash flows associated with this project for years 1 through 9

Gross Profit = 110*8000-25*8000-200000

=$480000

Depreciation= 1400000/10

=$140000

EBIT = Gross Profit - depreciation

=480000-140000

=$340000

Tax = 32%*340000

=$108800

Annual free cash flow = 340000+140000-108800

=$371200

----------

c) What is the terminal cash flow in year 10

Terminal cash flow = Annual cash flow - Net working capital

=371200-70000

=$301200

-----------

d) What is the project's NPV given a 8 percent required rate of return

Hence,the NPV is $1128358.67

Year Cash flow Present Value 0           (1,330,000) -1330000 1 371200 343703.70 2 371200 318244.17 3 371200 294670.53 4 371200 272843.08 5 371200 252632.48 6 371200 233918.97 7 371200 216591.63 8 371200 200547.81 9 371200 185692.42 10 301200 139513.88 NPV 1128358.67

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.