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 $214,000 per year. Once in production, the bike is expected to make $291,884 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 9.8%.

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? Round to two decimal places.

I already worked the correct answers for parts a and b, but I am stuck on part c.

The answers are:

a. NPV = $94838 / Accept the investment

b IRR = 11.22% / Maximum deviation = 1.42%

c. ????

Explanation / Answer

If the Development Last for 6 Years, NPV = $94838

If the Development Last for 7 Years: NPV = -108526

IRR (using excel)= 8.3360%

Cost of Capital = 9.8%

IRR is less than Cost of Capital, Hence Reject the Project.

Hence If Development last for 7 Years, NPV will be negative and IRR will be less than Cost of Capital and hence will change the decision from accepting to rejecting the Project.

Year Cash Flows PV Factor @ 9.8% Present Value of CashFlows Cumulative Discounted CashFlows 1 -$214,000 0.910746812 -$194,899.82 -$194,899.82 2 -$214,000 0.829459756 -$177,504.39 -$372,404.21 3 -$214,000 0.755427829 -$161,661.56 -$534,065.77 4 -$214,000 0.688003487 -$147,232.75 -$681,298.52 5 -$214,000 0.626596983 -$134,091.75 -$815,390.27 6 -$214,000 0.570671205 -$122,123.64 -$937,513.91 7 $291,884 0.519736981 $151,702.91 -$785,811.00 8 $291,884 0.473348799 $138,162.94 -$647,648.06 9 $291,884 0.431100909 $125,831.46 -$521,816.60 10 $291,884 0.392623779 $114,600.60 -$407,216.00 11 $291,884 0.357580855 $104,372.13 -$302,843.87 12 $291,884 0.325665624 $95,056.59 -$207,787.28 13 $291,884 0.296598929 $86,572.48 -$121,214.80 14 $291,884 0.270126529 $78,845.61 -$42,369.19 15 $291,884 0.246016875 $71,808.39 $29,439.20 16 $291,884 0.224059085 $65,399.26 $94,838.46

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