Problem regarding the existing asset

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Reference no: EM13743789

Problem - Existing asset

Replacement problem

Problem 1:

Consider the following for an 8 year special revenue generating project. (this is the base case)

Sales revenue $250,000 in the first year and will increase by 20% per year for the next 4 years.In year 6 the revenue will decrease by 15% a year through year 8.There is no expected cash flow after 8 years as this venture has a constrained timeline and no expected value after 8 years.

Costs of goods sold will be 70% of sales.

Advertising and administrative expenses will be fixed at $10,000 per year.

Equipment will be purchased for $300,000 and will be depreciated using the 7 year MACRS asset class depreciation schedule.Salvage value is expected to be $25,000

Working capital investment in year 0 is estimated to be $20,000 and is expected to be recovered in the final year of the project.

Cost of Capital is 8% and Tax Rate is 30%.

A: Base Case scenario

Calculate the project's NPV

What is your recommendation?

B: Pessimistic View

What is the impact on NPV based on pessimistic assumptions (consider both at the same time):

If Sales Revenue in the first year was only $150,000 and only increase by 10% for the next 4 years and then decline by 20% a year through year 8?
If Cost of Goods Sold were 75% of sales?

Reference no: EM13743789

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