(Calculating free cash flows) At present, Solartech
Skateboards is considering expanding its product line to
includegas-powered skateboards; however, it is questionable how
well they will be received by skateboarders. Although you feel
there is a 70 percent chance you will sell 12,000 of these per year
for 10 years (after which time this project is expected to shut
down because solar-powered skateboards will become more popular),
you also recognize that there is a 15 percent chance that you will
only sell 3,000 and also a 15 percent chance you will sell 17,000.
The gas skateboards would sell for $140 each and have a variable
cost of $35 each. Regardless of how many you sell, the annual
fixed costs associated with production would be $130,000. In
addition, there would be an initial expenditure of $800,000
associated with the purchase of new production equipment. It is
assumed that this initial expenditure will be depreciated using the
simplified straight-line method down to zero over 10 years.
Because of the number of stores that will need inventory, the
working capital requirements are the same regardless of the level
of sales. This project will require a one-time initial investment
of $50,000 in net working capital, and that working-capital
investment will be recovered when the project is shut down.
Finally, assume that the firm's marginal tax rate is 34
percent.
a. What is the initial outlay associated with the project?
b. What are the annual free cash flows associated with the project for years 1 through 9 under each sales forecast? What are the expected annual free cash flows for years 1 through 9?
c. What is the terminal cash flow in year 10 (that is, what is the free cash flow in year 10 plus any additional cash flows associated with the termination of the project)?
d. Using the expected free cash flows, what is the project's NPV given a required rate of return of 9 percent? What would theproject's NPV be if 12,000 skateboards were sold?
a. What is the initial outlay associated with the project?
b. What are the annual free cash flows associated with the project for years 1 through 9 under each sales forecast? What are the expected annual free cash flows for years 1 through 9?
c. What is the terminal cash flow in year 10 (that is, what is the free cash flow in year 10 plus any additional cash flows associated with the termination of the project)?
d. Using the expected free cash flows, what is the project's NPV given a required rate of return of 9 percent? What would theproject's NPV be if 12,000 skateboards were sold?
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