FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Devel
ID: 2815093 • Letter: F
Question
FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $223,000 per year. Once in production, the bike is expected to make $ 356,800 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 the investment?
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.
Explanation / Answer
Computation of present value year Cash flow PVIF @10% Present value 1 -223000 0.9091 (202,727) 2 -223000 0.8264 (184,298) 3 -223000 0.7513 (167,543) 4 -223000 0.6830 (152,312) 5 -223000 0.6209 (138,465) 6 -223000 0.5645 (125,878) 7 356,800 0.5132 183,095 8 356,800 0.4665 166,450 9 356,800 0.4241 151,318 10 356,800 0.3855 137,562 11 356,800 0.3505 125,056 12 356,800 0.3186 113,687 13 356,800 0.2897 103,352 14 356,800 0.2633 93,957 15 356,800 0.2394 85,415 16 356,800 0.2176 77,650 Net present value 266,319 negative values are cash outflow and positive values are cash inflows. Answer a) NPV = 266,319 Answer b) IRR = rate at which present value of cash flow = present value of cash outflow using excel formula we have 13.65% if cost of capital increases above 13.65% (or increased by more than 3.65% vs currnet 10%) decision will change . Answer C) NPV of the investment if the cost of capital is 15% year Cash flow PVIF @15% Present value 1 -223000 0.8696 (193,913) 2 -223000 0.7561 (168,620) 3 -223000 0.6575 (146,626) 4 -223000 0.5718 (127,501) 5 -223000 0.4972 (110,870) 6 -223000 0.4323 (96,409) 7 356,800 0.3759 134,134 8 356,800 0.3269 116,639 9 356,800 0.2843 101,425 10 356,800 0.2472 88,196 11 356,800 0.2149 76,692 12 356,800 0.1869 66,688 13 356,800 0.1625 57,990 14 356,800 0.1413 50,426 15 356,800 0.1229 43,849 16 356,800 0.1069 38,129 Net present value (69,772) NPV is negative @ 15% discount rate = (69,772)
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