Problem $8-11$

FastTrack Bikes, Inc., is thinking of developing a new composite road bike. Development will take six years and the cost is $$200,000$ per year. Once in production, the bike is expected to make $$300,000$ per year for $10$ years. The cash inflows begin at the end of year $7.$ Assuming the cost of capital is $10\%$:

a$.$ Calculate the NPV of this investment opportunity. Should the company make the investment?

b$.$ Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.

c$.$ How long must development last to change the decision?

Annual development cost $(200,000)$

Number of years to develop $6$

Cash flows in production $300,000$

Number of years in production $10$

Cost of capital $10\mathrm{.}00\%$

PV of development costs

PV of production inflows

a$.$ NPV

No$,$ they should not invest

$012345$

b$.$ Cash flows for IRR: $0(200000)(200000)(200000)(200000)(200000)$

IRR

The decision will change if the cost of capital deviates by more than

c$.$ Annual development cost $(200,000)$

Number of years to develop $6\mathrm{.}85$

Cash flows in production $300,000$

Number of years in production

Cost of capital $10\mathrm{.}00\%$

PV of development costs

PV of production inflows

NPV

Number of years of development to break even:

Assuming the cost of capital is $14\%$:

a$.$ Calculate the NPV of this investment opportunity. Should the company make the investment?

b$.$ How much must this cost of capital estimate deviate to change the decision?

c$.$ How long must development last to change the decision?

Annual development cost $(200,000)$

Number of years to develop $6$

Cash flows in production $300,000$

Number of years in production $10$

Cost of capital $14\mathrm{.}00\%$

PV of development costs

PV of production inflows

a$.$ NPV

No$,$ they should not invest

$012345$

b$.$ Cash flows for IRR: $0(200000)(200000)(200000)(200000)(200000)$

IRR

The decision will change if the cost of capital deviates by more than

c$.$ Annual development cost $(200,000)$

Number of years to develop

Cash flows in production $300,000\mathrm{.}00$

Number of years in production $10\mathrm{.}000$

Cost of capital $14\mathrm{.}00\%$

PV of development costs

PV of production inflows

NPV

Number of years in development to break even: