Amazon is considering producing a new laptop. This will be a two year project. a
ID: 2658035 • Letter: A
Question
Amazon is considering producing a new laptop. This will be a two year project.
a. New equipment will cost $10,000,000 and depreciation is by the 5-year MACRS method.
b. The project requires an initial investment in net working capital of $1,000,000 (which will be recaptured at the end of the project).
c. Amazon paid $500,000 last year to conduct a market study to see the demand for an Amazon laptop.
d. The new laptop will directly generate $6,000,000 in revenues each year of the project’s life.
e. In addition to the revenues in d., the new laptop will also increase existing Amazon App Store revenues by $500,000 each year of the project’s life.
f. In addition to the revenues in d., the new laptop will also decrease existing Kindle revenues by $1,000,000 each year of the project’s life.
g. The new project will have expenses of $1,500,000 each year of the project's life.
h. There is no interest expense.
i. At the conclusion of the project in two years, the equipment can be sold for $5,000,000.
j. The firm’s marginal tax rate is 25 percent, and the project’s cost of capital is 11 percent.
The following is the MACRS Depreciation Table:
Year
3-year
5-year
7-year
1
33.33%
20.00%
14.29%
2
44.44%
32.00%
24.49%
3
14.82%
19.20%
17.49%
4
7.41%
11.52%
12.49%
5
11.52%
8.93%
6
5.76%
8.93%
7
8.93%
8
4.45%
Question 1
What is the terminal cash flow (the last cash flow of the project not including the OCF)?
Question 2
What is the initial investment in this project (enter as a negative number)?
Question 3
What is the after tax OCF in year 1?
Question 4
What is the after tax OCF in year 2?
Question 5
What is the cash flow in year 0 (CF0)?
Question 6
What is the cash flow in year 1 (CF1)?
Question 7
What is the cash flow in year 2 (CF2)?
Question 8
What is the project's NPV?
Question 9
Should you ACCEPT or REJECT the project?
Accept
Reject
Year
3-year
5-year
7-year
1
33.33%
20.00%
14.29%
2
44.44%
32.00%
24.49%
3
14.82%
19.20%
17.49%
4
7.41%
11.52%
12.49%
5
11.52%
8.93%
6
5.76%
8.93%
7
8.93%
8
4.45%
Explanation / Answer
Answer 1 Calculation of terminal cash flow After tax sale value of equipment $4,950,000.00 Recovery of net working capital $1,000,000.00 Terminal Cash flow $5,950,000.00 Calculation after tax sale value of equipment in two years Purchase cost $10,000,000.00 Less : Depreciation @ 20% for 1st Year $2,000,000.00 Less : Depreciation @ 32% for 2nd Year $3,200,000.00 Book value at the end of 2nd Year $4,800,000.00 Less : Sale value of equipment $5,000,000.00 Gain on sale $200,000.00 Tax @ 25% on Gain $50,000.00 After tax sale value of equipment $4,950,000.00 Answer 2 The initial investment in this project Purchase cost of new equipment -$10,000,000.00 Investment in net working capital -$1,000,000.00 Initial Investment in the project -$11,000,000.00 Answer 3 The after tax OCF in year 1 Revenue - Project Revenue $6,000,000.00 - Increase in Amazon App Store revenues $500,000.00 - Decrease in Kindle revenues -$1,000,000.00 Net Revenue $5,500,000.00 Expenses -$1,500,000.00 Profit before tax (except depreciation) $4,000,000.00 Tax @ 25% on above -$1,000,000.00 Depreciation Tax shield (2000000*25%) $500,000.00 OCF in Year 1 $3,500,000.00 Answer 4 The after tax OCF in year 2 Revenue - Project Revenue $6,000,000.00 - Increase in Amazon App Store revenues $500,000.00 - Decrease in Kindle revenues -$1,000,000.00 Net Revenue $5,500,000.00 Expenses -$1,500,000.00 Profit before tax (except depreciation) $4,000,000.00 Tax @ 25% on above -$1,000,000.00 Depreciation Tax shield (3200000*25%) $800,000.00 OCF in Year 2 $3,800,000.00 Answer 5 The cash flow in year 0 (CF0) -$11,000,000.00 Answer 6 The cash flow in year 1 (CF1) $3,500,000.00 Answer 7 The cash flow in year 2 (CF2) $9,750,000.00 Answer 8 Calculation of NPV Year $0.00 1 2 NPV Cash flow -$11,000,000.00 $3,500,000.00 $9,750,000.00 x Discount factor @ 11% 1.00000 0.909090909 0.826446281 Present Values -$11,000,000.00 $3,181,818.18 $8,057,851.24 $239,669.42 NPV of project = $239,669.42 Answer 9 NPV of project is positive , hence Amazon should accept the project.
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