W Mart is considering offering one hour photo developing in their store. Assume the project of providing the new service has a life of 5 years and the firm expects that sales from the new service will be $100,000 per year. WMart currently offers overnight film processing with annual sales of $80,000. While many of the one hour photo sales will be to new customers, WMart estimates that if the company starts the new service, 60% of their current overnight photo customers will switch to the new service. If the company fails to provide the new service, half of the switching customers (i.e. 60% of the current customers) will switch to a competitor for similar service. Further, lets assume the new service has no impact on the cost of the existing overnight film processing service.

The company need to purchase a new photo machine for the new service at a cost of

$15,000. For tax purpose, assume straight line depreciation, and the equipment will be

obsolete after 5 years.

For the new one hour photo service, the company will need to train two staff to operate the machine, which will result in an upfront cost of $1,500. In addition, there is an annual maintenance expense of $5,000 when the machine operates.

W Mart has a cost of capital of 10%. Consider no change in net working capital associated with the project. Assume the marginal tax rate is 40% and all cash flows occur at year end.

a) What are the free cash flows of the project?

b) Calculate the NPV of the project. Should the company invest or not? Why? 

Answer rating: 100% (QA)

To calculate the free cash flows FCF of the project and its Net Present Value NPV we need to consider the costs and revenues associated with the new onehour photo service over the 5year period First l... View the full answer