FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Devel

Question

FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $196,400 per year. Once in production, the bike is expected to make $303,533 per year for 10 years. The cash inflows begin at the end of year 7.

For parts a-c, assume the cost of capital is 9.1 %

a. Calculate the NPV of this investment opportunity. Should the company make the investment?

b. Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.

c. How long must development last to change the decision?

For parts d-f, assume the cost of capital is 14.4 %.

d. Calculate the NPV of this investment opportunity. Should the company make the investment?

e. How much must this cost of capital estimate deviate to change the decision?

f. How long must development last to change the decision?

Explanation / Answer

Here first we should write the cashflows of the firm which would be

The NPV at 9.1% can be found out as prsent value at dicount rate of 9.1%

=-196400/(1.091) -196400/(1.091)^2 ..................................+303533/(1.091)^16

=271657.28

As NPV is gerater than zero project should be undertaken

IRR of the investment can be found in excel foor using financial calculator

=IRR( Cashflows)

=13.12%

As IRR is greater than 9.1% project should be undertaken

PV (benefit) = FV at year N

PV benfit the present valeu of the profitt firm recieves

That is the present value of the 303533 at 9.1% for 10 year will be equal to

1939425.90

No the future value of cost of 196400 should be equal to this

NPER(0.091,-196400,0,1939425.9,0)

=7.36

d) NPV 14.1% would be -46,910

NPV is negative hence prokjecy should not be accepted

e) IRR at would be 13.12% which is les than 14.1%

f) As similair to quesion to c presnet value of postive cashflows ta 14.1%

would be 1577103.63

Now future value of NPER(0.141,-196400,0,1577103.63,0) = 5.74 years

Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 -196400 -196400 -196400 -196400 -196400 -196400 303533 303533 303533 303533 303533 303533 303533 303533 303533 303533

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