Answered Essay: Please help I am lost :( Foundations of Finance Chapter 11 Study Problem 7

(Calculating free cash flows) At present, Solar tech Skateboards is considering expanding its product line to include gas-powered skateboards, howeverit is questionable how well they will be received by skateboarders. While you feel there is a 60 percent chance you will sell 10,000 of these per year for 10 years (after which time this project is expected to shut down because solar powered skateboards will become more popular, you also recognize that there is a 20 percent chance that you will only sen 3000 and also a 20 percent chance you will sell 13,000. The gas skateboards would sell for $100 each and have a variable cost of $40 each. Regardless of how many you sell, the annual taxed costs associated with production would be $160,000. In addition, there would be a $1,000,000 initial expenditure associated with the purchase of new production equipmentIt is assumed that this initial expenditure win be depreciated using the simplied straight-down to zero over of the number of stores that will need line method 10 years because inventory, the working capital requirements are the same regardless of the level of sales, and this project will require a onetime initial investment of $50,000 in net working capital, and that working capital investment will be recovered when the project is shut down Finally, assume that the firms marginal tax rate is 34 percent. a. What is the initial outlay associated with the project? B . what are the annual tree cash flows associated with the project for years 1 through 9 under each sales forecast? What are the expected annual free cash flows for years through 97 c. What is the terminal cash now in year 10 (that is, what is the tree cash now in year 10 plus any additional cash flows associated with the termination of the project? d, using the expected tree cash flows, what is the projects NPV given a 10 percent required rate of return? What would the projects NPV be if 10,000 skateboards were sold?Please help I am lost 🙁 Foundations of Finance Chapter 11 Study Problem 7

(Calculating free cash flows) At present, Solar tech Skateboards is considering expanding its product line to include gas-powered skateboards, howeverit is questionable how well they will be received by skateboarders. While you feel there is a 60 percent chance you will sell 10,000 of these per year for 10 years (after which time this project is expected to shut down because solar powered skateboards will become more popular, you also recognize that there is a 20 percent chance that you will only sen 3000 and also a 20 percent chance you will sell 13,000. The gas skateboards would sell for $100 each and have a variable cost of $40 each. Regardless of how many you sell, the annual taxed costs associated with production would be $160,000. In addition, there would be a $1,000,000 initial expenditure associated with the purchase of new production equipmentIt is assumed that this initial expenditure win be depreciated using the simplied straight-down to zero over of the number of stores that will need line method 10 years because inventory, the working capital requirements are the same regardless of the level of sales, and this project will require a onetime initial investment of $50,000 in net working capital, and that working capital investment will be recovered when the project is shut down Finally, assume that the firm’s marginal tax rate is 34 percent. a. What is the initial outlay associated with the project? B . what are the annual tree cash flows associated with the project for years 1 through 9 under each sales forecast? What are the expected annual free cash flows for years through 97 c. What is the terminal cash now in year 10 (that is, what is the tree cash now in year 10 plus any additional cash flows associated with the termination of the project? d, using the expected tree cash flows, what is the projects NPV given a 10 percent required rate of return? What would the projects NPV be if 10,000 skateboards were soldd

Expert Answer

 

a. Initial outlay associated with the project:

Initial expenditure associated with purchase of new production equipment = $ 1,000,000

Initial investment in net working capital = $ 50,000

Total Initial outlay = $ 1,000,000 + $ 50,000 = $ 1,050,000

b. For selling 10,000 skateboards, EBIT =

=[10,000 x ($100 – $40)] – $ 160,000 – $100,000(depreciation)

= $ 340,000

EBIT after tax = $ 340,000 x (1 – 0.34) = $ 224,400

Annual Free Cash Flows = $ 224,400 + $ 100,000 = $ 324,400

For selling 3,000 skateboards, EBIT =

=[3000 x ($100-$40)] – $160,000 – $100,000

= – $ 80,000

EBIT after tax = – $80,000 x (1 – 0.34) = – $52,800

Annual Free Cash Flows = -$ 52,800 + $ 100,000 = $ 47,200

For selling 13,000 skateboards, EBIT =

=[13,000 x ($100-$40)] – $160,000 – $100,000

=$ 520,000

EBIT after tax = $ 520,000 x (1 – 0.34) = $ 343,200

Annual Free Cash Flows = $ 343,200 + $ 100,000 = $ 443,200

c. Terminal Cash Flow in Year 10:

Terminal Cash Flow = Annual year cash flow + Initial working capital investment

For 10,000 skateboards sales: $ 324,400 + $ 50,000 = $ 374,400

For 3,000 skateboards sales: $ 47,200 + $ 50,000 = $ 97,200

For 13,000 skateboards sales: $ 443,200 + $ 50,000 = $ 493,200

d. The following is the project’s NPV if 10,000 skateboards were sold:

NPV is all the cash flows discounted.

= Initial outflow at the end of Year 0 + Discounted Cash Flows for 9 years + Discounted Cash Flow for the 10th year

= – $1,050,000 + ($ 324,400 x discounting factor at the rate of 10% for 9 years) + ($ 374,400 x discounting factor at the rate of 10% for the 10th year)

= – $ 1,050,000 + ($ 324,400 x 5.759) + ($ 374,400 x 0.3855)

= $ 962,551

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