week4 DQ

profileRiley08
DQweek4.pdf

DQ

When a business considers investing in a new project, the decision must be carefully evaluated.

Businesses should invest in projects that are expected to add value to the company. One

method to determine the added value of a project is net present value (NPV) analysis. NVP

analysis determines the present value of the benefits and costs of a project. If the project’s NPV

is greater than $0, then the project is considered to add value to the company. For this

discussion, you will practice calculating the added value of project using the NPV.

Prepare:

Prior to beginning work on this discussion forum,

• Complete the Week 4 – Learning Activity 1.

• Read Chapter 7 of Essentials of finance.

For the initial post, you will complete the NPV problem below. You will not be able to see other

students’ posts until you post your initial post.

Problem:

A large auto company has just completed the research and development (R&D) on a new

product, the Electrobicycle. The Electrobicycle is an electronic, climate-controlled bicycle with

zero emissions. The R&D efforts focused on developing the capability to utilize electricity to

power bicycles. Ultimately, the auto company expects Electrobicycles to be popular for most

urban citizens due to convenience and low cost.

The R&D, which cost $3 million, is complete and paid for. The plant and equipment to mass

produce the Electrobicycles will cost $2 million. This plant and equipment will be depreciated

over 5 years using the straight-line method to zero book value ($400,000 per year). A working

capital investment of $1 million will be needed at the beginning of the project. A working

capital investment of $200,000 per year will be needed thereafter.

At the end of 5 years, the auto company believes there will be no more sales opportunities for

Electrobicycles and will cease all production. Thus, at the end of the project, all working capital

investments (the $1 million initial investment and the $200,000 per year) will be recovered at

full value. The plant and equipment will be scrapped for a salvage value of $300,000 (after tax).

The company expects moderate sales in years 1 and 2, and then significant growth in each year

thereafter as consumers adopt the Electrobicycles. Revenues and earnings will cease at the end

of Year 5. The revenues, after-tax earnings, and cash flow for the 5-year life of the project are

shown in this table.

Table 1

Projected Electrobicycle Financial Projection

Numbers in $000’s

Today Year 1 Year 2 Year 3 Year 4 Year 5

Revenues $1,000 $1,500 $3,000 $6,000 $12,000 After-tax earnings

($500) $100 $300 $600 $1,200

Project Cash

Flow

After-tax earnings

($500) $100 $300 $600 $1,200

Plus: Depreciation

$400 $400 $400 $400 $400

Less: Cost of plant, equipment

($2,000) $0 $0 $0 $0 $0

Less: Working capital

($1,000) ($200) ($200) ($200) ($200) ($200)

Plus: Recovery of working capital

n/a n/a n/a n/a $2,000

Plus: Salvage value

n/a n/a n/a n/a $600

Annual project cash flow

($300) $300 $500 $800 $4,000

Note: n/a = not applicable

Calculate:

• Determine the NPV for the Electrobicycle project. Use the annual project cash flow from

the table above. For the required rate of return, use the percent value from your

birthday date. For example, if your birthday falls on the 16th of the month, the required

rate of return would be 16%.

o For guidance, review Section 7.1 of the textbook, NPV Example: The Pizza

Scooter Delivery Project Revisited.

Write:

In your post, include the following:

• Calculate the NPV of the Electrobicycle project. Be sure to show your NPV calculations.

• Explain, in your own words, why working capital investments are subtracted each year

in the cash flows.

• Explain, in your own words, the meaning of the required rate of return for the project.

• Assume the auto company has a required rate of return of 15%. Based on the required

rate of return you used for the Electrobicycles (based on your birthday date), is the

Electrobicycle project more or less risky than the auto company? Explain your answer.

• Based on your concluded NPV, should the company invest in this project to build

Electrobicycles? Justify your answer.

Guided Response: Review several of your colleagues’ posts, and reply to at least two of your

peers by 11:59 p.m. on Day 7 of the week. You must respond to two classmates who have

completed different calculations than you. In your written responses to your classmates,

address the following:

• Confirm the calculations or explain a correction to the calculation in the initial post.

• Compare how the required rate of return you used differs from your classmate’s rate of

return.

• Explain how the different rate of returns impacted the concluded NPV.

• Explain why the salvage value is added to the cash flows in the final year of the project.