. (Calculating free cash flows) Presently, Solartech Skateboards is considering

Question

. (Calculating free cash flows) Presently, Solartech Skateboards is considering expanding its product line to include gas-powered skateboards; however, it is questionable how well they will be received by skateboarders. While you feel there is a 60 percent chance you will sell 10,000 of these per year for 10 years (after which time this project is expected to shut down because solar-powered skateboards will become more popular), you also recognize that there is a 20 percent chance that you will only sell 3,000 and also a 20 percent chance you will sell 13,000. The gas skateboards would sell for $100 each and have a variable cost of $40 each. Regardless of how many you sell, the annual fixed costs associated with production would be $160,000. In addition, there would be a $1,000,000 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. Because of the number of stores that will need inventory, the working capital requirements are the same regardless of the level of sales, and this project will require a one-time initial investment of $50,000 in net working capital, and that working-capital investment will be recovered when the project is shut down. Finally, assume that the firm

Explanation / Answer

(Calculating free cash flows) You are considering expanding your product line that currently
consists of skateboards to include gas-powered skateboards, and you feel you can sell
10,000 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 $100 each with variable
costs of $40 for each one produced, while annual fixed costs associated with production
would be $160,000. In addition, there would be a $1,000,000 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
will also require a one-time initial investment of $50,000 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 34 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?

Optional Information:
Country/State/Province of question: NM

ANS:

Terminal cash flow in year 10 will just be nearly the same as the annual year cash flow except they recover the 50000 initial working capital investment as the problem described so it will be:

324400+50000 = 374400


NPV = All the cash flows discounted

I don't have a financial calculator with me that allows me to do NPV so I used this and plugged the numbers in (-1050000 for initial cost, 324400 for the first 9 cash flows and 374400 for the last cash flow): http://www.investopedia.com/calculator/NetPresentValue.aspx


NPV = -1050000 + 324400/1.1 + 324400/(1.1^2) + ...+ 324400/(1.1^9) + 374400/(1.1^10) = 962574.73




You may want to check this NPV on a financial calculator if you have one with the cash flows that were found.

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