You are evaluating the HomeNet project under the following assumptions: Sales of

Question

You are evaluating the HomeNet project under the following assumptions: Sales of 50,000 units in year 1 increasing by 50,000 units per year over the life of the project, a year 1 sales price of $ 260/unit, decreasing by 10% annually and a year 1 cost of $120/unit decreasing by 20% annually. In addition, new tax laws allow you to depreciate the equipment, costing $7.5 million, over three years using straight-line depreciation. Research and development expenditures total $15 million in year 0 and selling, general, and administrative expenses are $2.8 million per year (assuming there is no cannibalization) Also assume HomeNet will have no incremental cash or inventory requirements (products will be shipped directly from the contract manufacturer to customers). However, receivables related to HomeNet are pected to account for 15 % of annual sales, and payables are expected to be 15 % of the annual cost of goods sold. Under these assumptions the unlevered net income, net working capital requirements and free cash flow are shown in the Table LOADING Using the FCF projections given: a. Calculate the NPV of the HomeNet project assuming a cost of capital of 10 %, 12% and 14% b. What is the IRR of the project in this case?

Explanation / Answer

a. NPV at cost of capital 10%

NPV= 26,635.08-16,500= $10,135.08

b. NPV at cost of capital 12%

0.567

NPV= $25,194.75-16,500= $8,694.75

c. NPV at cost of capital 14%

NPV= 23837.35-16,500= $7337.35

IRR is the rate of return at which the NPV becomes zero. In either of this rates, the NPV is far above than zero. So non of these rates can be depicted as IRR. IRR appears to be at or above 20%.

Year 0 1 2 3 4 5 FCF (16,500) 2,470 6,580 10,421 12,800 3,843 PVF 1 0.909 0.826 0.751 0.683 0.621 PVAF (16,500) 2245.23 5435.08 7826.17 8742.4 2386.2

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