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 9,000 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 $170,000. In addition, there would be a $1,500,000 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 $60,000 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 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 10 percent required rate of

Explanation / Answer

a)Initial outlay for the project Cost of the new production equipment 1500000 Initial net working capital 60000 Total initial outlay 1560000 b)Annual free cash flows for years 1-9 Units Rate Value Annual sales 9000 110 990000 Less: Var.cost 9000 25 225000 Gross margin 9000 85 765000 Less: Annual Fixed costs 170000 Net income before depreciation 595000 Less:Annual depreciation 1500000/10 150000 Income before tax 445000 Less:Tax @31% on 445000 137950 Net income after tax 307050 Addback :Depreciation(non-cash expense) 150000 Annual free cash flow 457050 c)Annual cash flow in year 10 Annual cash flow as above 457050 Recovery of net working capital 60000 Total free terminal cash flow in yr. 10 517050 d)The project's NPV @ 10 percent required rate of return Year Outflow/inflow PV F @ 10% PV 0 -1560000 1 -1560000 1 457050 0.9091 415504 2 457050 0.8264 377706 3 457050 0.7513 343382 4 457050 0.683 312165 5 457050 0.6209 283782 6 457050 0.5645 258005 7 457050 0.5132 234558 8 457050 0.4665 213214 9 457050 0.4241 193835 10 517050 0.3855 199323 NPV 1271474

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