Question 2 - Virtual Ray (20 marks)
Ray University, always on the cutting edge of technology, is analyzing the possibility of providing virtual courses for its finance students. This virtual university setting would provide the next generation of online courses by using 3D simulated digital environment where users can socialize, connect and create using voice and text chat. Your current finance instructor knows you are a star student and asks you to perform an NPV analysis on the project. Below are the estimated expenses and revenues. Assume the cost of capital is 7% and the expected life of this new generation of online courses is 5 years.
• Annual revenues: $800,000 first year, growing at an annual rate of 20% thereafter.
• Annual expenses: $175,000 first year, declining at an annual rate of 3% thereafter.
• Increase in working capital: $160,000 immediately, half of which will be recovered at the end of year 4 and the remainder recovered at the end of year 5.
• Cost of R&D incurred over the past two years: $350,000.
• Cost of equipment: $3,000,000
• Expected salvage value at the end of 5 years: $50,000
• CCA rate: 40% declining balance (half-year rule applies)
• Tax rate: 10%
As well, Ray expects net revenues (after-tax) from existing courses to be reduced by $150,000 each year. Should Ray proceed with this virtual course project?
Help is given to perform an NPV analysis.