You are the financial analyst for a tennis racket manufacturer. The company is c

Question

You are the financial analyst for a tennis racket manufacturer. The company is considering using a graphite like material in its tennis rackets. The company has estimated the information in the following table about the market for a racket with the new material. The company expects to sell the racket for six years. The equipment required for the project has no salvage value. The required return for projects of this type is 13 percent, and the company has a 40 percent tax rate.

Pessimistic Expected Optimistic Market size 105,000 120,000 145,000 Market share 20 % 23 % 25 % Selling price $ 150 $ 155 $ 161 Variable costs per unit $ 104 $ 99 $ 98 Fixed costs per year $ 965,000 $ 920,000 $ 890,000 Initial investment $ 1,900,000 $ 1,800,00 $ 1,700,000

Explanation / Answer

Unit sales = Market size*market share

Operating cashflow = (Sales - Costs)*(1-Tax) + Tax*Depreciation

Depreciation = Initial investment/Number of years

Pessimistic:

OCF = ((150-104)*21000 - 965000)*(1-0.4) + 0.4*190000/6 = 127266.67

NPV = -1900000 + 127266.67/(1+0.13)^1 + 127266.67/(1+0.13)^2 + 127266.67/(1+0.13)^3 + 127266.67/(1+0.13)^4 + 127266.67/(1+0.13)^5 + 127266.67/(1+0.13)^6 = -$1391245.15

Expected:

OCF = ((155-99)*27600 - 920000)*(1-0.4) + 0.4*1800000/6 = 495360.00

NPV = -1800000 + 495360.00/(1+0.13)^1 + 495360.00/(1+0.13)^2 + 495360.00/(1+0.13)^3 + 495360.00/(1+0.13)^4 + 495360.00/(1+0.13)^5 + 495360.00/(1+0.13)^6 = $180226.26

Optimistic:

OCF = ((161-98)*36250 - 890000)*(1-0.4) + 0.4*1700000/6 = 949583.33

NPV = -1700000 + 949583.33/(1+0.13)^1 + 949583.33/(1+0.13)^2 + 949583.33/(1+0.13)^3 + 949583.33/(1+0.13)^4 + 949583.33/(1+0.13)^5 + 949583.33/(1+0.13)^6 = $2096006.64

Unit Sales Price Variable costs Fixed costs Pessimistic 21000.00 150.00 104.00 965000.00 Expected 27600.00 155.00 99.00 920000.00 Optimistic 36250.00 161.00 98.00 890000.00

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