The ABC company sells regular watches, priced at $35. It sold 10000 pieces this past year (year 0), and both the price and sales volume are expected to grow at the rate of inflation. It is proposing to introduce a new line of luxury watches. It is expected that luxury watch sales will be 50000 pieces in the first year, and rise at a constant percentage rate to 100000 in year 5, and then drop at a constant percentage rate to 60000 by year 10. Inflation is expected to be 2% in year 1, increase to 3% in years 2 through 7 and then remain at 3.5%. Fixed operating costs are expected to be $2 million per year. Variable costs will be 75% of sales in year 1, and then reduce by 3% every year to 48% in year 10. The initial sales price for the luxury watches will be $500 in year 1, and then will rise at the rate of inflation + 1% thereafter. Because it introduces the new luxury watches, it will reduce its sales of regular watches by 75% (pre-tax margin EBIT/Sales of 20%). It will have to use idle land it already owns, with a market value of $2 million. The buildings and machinery will cost $1 million at the start of each of the next two years year 1 and year 2, and the amount of working capital will be 10% of total yearly sales, and will be invested at the start of each year. The buildings and machinery will be depreciated to zero over 5 years, zero salvage value. Land will increase in value with inflation, and working capital will retain its value.

The tax rate is 35%, equity beta is 1.2, Rf is 5% and MRP is 7.5%. Over the next 10 years, ROE based on market values is expected to be 12%, ROA is expected to be 8%. Debt constitutes 25% of the firm's capital structure in market value terms. ABC has current debt ($1000 face value, 15 year bonds issued on August 2014), paying $35 semi-annual coupon and trading at $1012.50. 

Compute the NPV of the project.

Answer rating: 100% (QA)

here are the steps to calculate the NPV of the project Project cash flows for 10 years Sales reven... View the full answer