The following information pertains to a proposed new six-year venture for a firm
ID: 2675864 • Letter: T
Question
The following information pertains to a proposed new six-year venture for a firm:Pre-startup advertising and marketing expenses $ 80,000
Pre-startup cost of new equipment (assume 5-year SL) $200,000
Investment in market research undertaken last year $100,000
Sales volume in units (years 1 - 3) 50,000
Sales volume in units (years 4 - 6) 60,000
Selling price per unit $ 15
Gross margin on foregone current product sales (years 1 - 6) $ 50,000
Cost to manufacture (per unit) $ 8
Incremental cash expenses (years 1 - 6) $200,000
Corporate tax rate 34%
Corporate cost of capital 14%
Permanent working capital required at outset, to be restored to cash at the end of the project's life $ 50,000
a. Develop the cash flows for the project.
b. Calculate the net present value of the venture.
Explanation / Answer
a. Initial Cost = Advertising +cost of new equipment +Permanent working capital =$ 80,000 +$200,000 +$ 50,000 =$330,000 Annual Depreciation = $200,000/5=40,000 Cash Flow for (years 1 - 6) = (Revenue -Manufacturing Cost -Gross margin on foregone current product sales- annual depreciation)*(1-tax) +annual depreciation -Incremental cash expenses Cash Flow for (years 1 - 3) = (50,000*15 -50,000*8-$ 50,000 - $200,000/5)*(1-34% ) +$200,000/5 -$200,000 =11600 Cash Flow for (years 4 - 5) = (60,000*15 -60,000*8-$50,000 - $200,000/5)*(1-34% ) +$200,000/5 -$200,000 =57800 In year 6, there is no depreciation and initial working capital is recovered Cash Flow for (years 6) =(60,000*15 -60,000*8-$50,000)*(1-34% ) -$200,000 + $ 50,000 =94200 b. Net present value =-$330,000 +11600/1.14 +11600/1.14^2 +11600/1.14^3 +57800/1.14^4+57800/1.14^5 +94200/1.14^6 =-$195911
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