You are given the following information concerning a project for Havana: • The c

Question

You are given the following information concerning a project for Havana:

• The corporation is considering to produce a new range of flip-flops – the flop-flip - that they have been assured by their marketing department will be extremely popular among 18 to 25 year olds.

• Havana expects that flop-flips will sell mostly in California and New York.

• The corporation will need to set up a new manufacturing plant to produce the flop-flips. The plant would cost of $30 million.

• The project involving the flop-flips will be for five years.

• They predict the most popular color will be white.

• Three years ago Havana completed a project investigating whether the market was ready for flop-flips. The project cost $2.5 million and concluded “No”.

• The project will involve zero investment in net working capital.

• There are zero taxes.

• The firm’s discount rate is 6%.

• For simplicity, ignore depreciation (i.e. assume it is 0) and any cash flows related to salvage value.

What is the level ($ amount) of operating cash flows each year if the project has a NPV of $10 million? (the operating cash flow is the same each year)

Explanation / Answer

NPV would be calculated as -

NPV = Operating cash flows each year x cumulative present value factor (6%, 5 years) - Initial cost of plant

Required NPV is given as $10,000,000. Initial Cost being $30,000,000. Let operating cash flows be 'p'.

$10,000,000 = p x 4.21236378546 - $30,000,000

Or, p x 4.2136378546 = $40,000,000

Or, p = $9,495,856.01748 or $9,495,856

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