Problem # 1

Consider the following for an 8 year special revenue generating project. (this is the base case)

• Sales revenue $250,000 in the first year and will increase by 20% per year for the next 4 years. In year 6 the revenue will decrease by 15% a year through year 8. There is no expected cash flow after 8 years as this venture has a constrained timeline and no expected value after 8 years.
• Costs of goods sold will be 70% of sales.
• Advertising and administrative expenses will be fixed at $10,000 per year.
• Equipment will be purchased for $300,000 and will be depreciated using the 7 year MACRS asset class depreciation schedule. Salvage value is expected to be $25,000
• Working capital investment in year 0 is estimated to be $20,000 and is expected to be recovered in the final year of the project.

Cost of Capital is 8% and Tax Rate is 30%.

A: Base Case scenario

• Calculate the projects NPV
• What is your recommendation?

B: Pessimistic View

• What is the impact on NPV based on pessimistic assumptions (consider both at the same time):
  • If Sales Revenue in the first year was only $150,000 and only increase by 10% for the next 4 years and then decline by 20% a year through year 8?
  • If Cost of Goods Sold were 75% of sales?

Problem #2

Company needs to decide between two machines.

Machine A costs 10,000 and produce after tax cash flows of 3,000 per year for 5 years. No salvage.

Machine B costs 18,000 and produce after tax cash flows of 2,800 per year for 10 years. No salvage.

Discount rate is 8%

Which machine would you recommend?

Problem #3

Company needs to decide between two machines.

Machine C costs 10,000 and produce after tax cash flows of 4,000 per year for 3 years. No salvage.

Machine D costs 14,000 and produce after tax cash flows of 3,000 per year for 7 years. No salvage.

Discount rate is 8%

Which machine would you recommend?

Problem #4

Calculate NPV, Payback, Discounted Payback, IRR and Modified IRR for the following project

Initial Investment: -100,000

Annual project cash flow 22,000 for 6 years

Cost of capital is 6%