persistent inc is considering a project expected to last for 4 years based on fo
ID: 2733222 • Letter: P
Question
persistent inc is considering a project expected to last for 4 years based on following forecasts:
market size: 10,000 units
persistents share of the market: 30% of the market
sale price/unit $50
variable cost/unit $20
fixed costs: $20k per year
project costs are estimated at $150k depreciateed on a straight line basis to zero. working capital requirements at project inception are estimated to be $25k. the company spent $50k in market survey expenses in developing the project forecasts. assume the cost of capital is 8% and the corporate tax rate is 20%.
a. scompany uses NPV method to make capital spending decisions. should accept?
b. estimate of IRR? basis for estimate?
c. if co. costs of capital doubled what impact if any would have on decision to move forward with project assuming npv method is used for capital decision making. why?
Explanation / Answer
a)
Net present value = - $225,000+ $ 63,500 /( 1+0.08)1 + $ 63,500 /( 1+0.08)2 + $ 63,500 /( 1+0.08)3 + $ 83,500 / (1+0.08)4
Net present value = $ 21
The project should be accepted because the Net present value is positive .
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b) Estimate of IRR
Annuity = ( $ 63,500 + $ 63,500 +$ 63,500 +$ 83,500) / 4
Annuity = $ 68,500
Payback period = $ 225,000 / $ 68,500
Payback period = 3.28
From the Present value interest factor of annuity corresponding to value of 3.28 for 4 years = 9%
The NPV at 9% = $ 5,109.28
NPV at 8% = 20.65
IRR = 8% + 20.65 / 5109.28
IRR = 8.004%
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c) If cost of capital is doubled i.e 16%
The NPV = - $ 36,269.71
The project cannot be accepted because the NPV is negative when cost of capital is doubled .
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Particulars Year Annual revenues Annual expenses Depreciation per year Operating cash flows Initial cost 0 ($150,000) ($75,000) 0 ($225,000) 1 150000 80000 37500 63500 2 150000 80000 37500 63500 3 150000 80000 37500 63500 4 175000 80000 37500 83500Related Questions
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