Suppose a firm is considering the following project: to undertake the project, the firm will need to make a one-time investment of $130,000 in year 0. This specialized equipment can be depreciated using the straight-line method over the seven years, with a salvage value of $5,000 in year 7. Your sales and marketing team tell you that they estimate sales of 7,500 units in year 1, rising by roughly 35% (of units in the prior year) per year through year 5, then declining by 45% (of units in the prior year) each year through year 7. They assume the product is dead at that point, with 0 units demanded/sold in year 8. The inflation rate is forecast be 1.5% in year 1 and remain the same through the end of the project. The firm's real cost of capital is forecast to be 10% in year 1 and projected to increase by 2.5% each year through year 7. The tax rate is estimated to be a level 39%. Sales revenue per unit is expected to be $20.00 in year 1. Variable cost per unit is estimated at $10.00 in year 1. Cash fixed costs will be $15,000 in year 1. All will grow with inflation.

I have calculated that the initial investment is $130,000 and depreciation in each year is $17,857 [=($130,000-$5,000)/7].

I need help understanding the following questions and calculations:

• Real cost of capital in year 4
• Nominal cost of capital in year 4
• price per unit in year 4
• cash fixed cost in year 4
• unit sales in year 4
• how much tax is paid from the project in year 4
• NPV of the project

 

Answer rating: 100% (QA)

SOLUTION 1 Real cost of capital in year 4 The real cost of capital is the cost of capital adjusted f... View the full answer