FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Devel
ID: 2783757 • Letter: F
Question
FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $185,000 per year. Once in production, the bike is expected to make $259,000 per year for 10 years. Assume the cost of capital is 10%. a. Calculate the NPV of this investment opportunity, assuming all cash flows occur at the end of each year. Should the company make theinvestment? b. By how much must the cost of capital estimate deviate to change the decision? (Hint: Use Excel to calculate the IRR.) c. What is the NPV of the investment if the cost of capital is 15%? Note: Assume that all cash flows occur at the end of the appropriate year and that the inflows do not start until year 7.
a. Calculate the NPV of this investment opportunity, assuming all cash flows occur at the end of each year. Should the company make theinvestment?
The present value of the costs is
The present value of the benefits is
The net present value is
You should reject or accept the investment because the NPV is
.
b. By how much must the cost of capital estimate deviate to change the decision? (Hint: Use Excel to calculate the IRR.)
To change the decision, the deviation would need to b
(Round to two decimal places.
c. What is the NPV of the investment if the cost of capital is 15%?
The present value of the costs is
The present value of the benefits is
The NPV will be
Explanation / Answer
a) PV can be calculated using NPV function on a calculator
CF1 = CF2...CF6 = -185,000 => Comput NPV = PV of cost at 10% = -805,723.23
CF0...CF6 = 0, CF7= CF8... CF16 = 259,000 => PV of benefits at 10% = 898,328.02
NPV = 898,328.02 - 805,723.23 = 92,604.79
Accept the project as NPV > 0
b) IRR can be calculated using IRR function on a calculator
CF1 = CF2...CF6 = -185,000, CF7= CF8... CF16 = 259,000 => Compute IRR = 11.61%
c) If cost of capital is 15%, then PV of cost = -700,129.30
PV of benefits = 561,965.81
=> NPV = -138,163.49
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