Company has spent $250,000 on research to develop a new computer game. The company plans to spend
Question:
Company has spent $250,000 on research to develop a new computer game. The company plans to spend $1,400,000 on a machine to produce the new game. The shipping and installation costs for the new machine total $200,000, and these costs will be capitalized and depreciated along with the cost of the machine. The machine will be used for 3 years, has an estimated resale value of $200,000 at the end of 3 years, and will depreciate on a straight-line basis over 4 years. Revenue for the new game is expected to be $1,200,000 per year, with costs of $500,000 per year. The company has a tax rate of 35 percent, a cost of capital (discount rate) of 6 percent, and expects net working capital (NWC) to increase by $150,000 at the start of the project. This investment in NWC will be fully recovered at the end of the project. .
Complete the table below.
In the second table below, calculate the net present value (NPV) of the project.
Calculate the Profitability Index (PI) of the project.
Is the Internal Rate of Return (IRR) of the project greater than, equal to, or less than the cost of capital (discount rate)?
Should your company continue with this project? Explain based on the decision criteria for VAN, PI and IRR.
Year | 0 | 1 | 2 | 3 |
Revenue | ||||
costs | ||||
Depreciation | ||||
EBIT | ||||
Taxes | ||||
Net Income | ||||
operating cash flow | ||||
Change in net operating working capital | ||||
Change in gross fixed assets | ||||
Total free cash flow |
net present value | |
Profitability Index | |
Internal Rate of Return >, =, or < the cost of capital (discount rate)? | |
Continue with the project? Explain. |
Finance Applications and Theory
ISBN: 978-0077861681
3rd edition
Authors: Marcia Cornett, Troy Adair