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New Project evaluation: initial investment, cash flows, NPV, IRR

Project Evaluation:

Revenues generated by a new fad product are forecast as follows:
Year Revenues
1 $40,000.00
2 30,000.00
3 20,000.00
4 10,000.00
thereafter 0

Expenses are expected to be 40% of revenues, and working capital required in each year is expected to be 20% of revenues in the following year. The product requires an immediate investment of $45,000.00 in plant equipment.

a) What is the initial investment in the product? Remember working capital.
b) If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight-line depreciation, and the firm's tax rate is 40%, what are the project cash flows in each year?
c) If the opportunity cost of capital is 12%, what is the project Net Present Value?
d) What is the project Internal Rate of Return?

Please show all work.

Thanks!

Solution Preview

a) What is the initial investment in the product? Remember working capital.
Initial investment is simply the sum of immediate investment ($45,000) and the working capital to start the operation, which is the 20% of first year's revenue ($40,000). Thus:

I= 45,000 + 40,000 x 0.2= $53,000

b) If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight-line depreciation, and the firm's tax rate is 40%, what are the project cash flows in each year?
Let's write the formula of the cash flow (CF) first:

CF = Net Operating Profit - Taxes - Net Change in Working Capital

Now we need to find the net operating profit (NOP) first in order to use in our formula. NOP is the difference between the revenues (R) and the expenses ...

Solution Summary

The solution is a detailed set of facts and calculations to make the answers easy to understand.

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