1. 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.
·

2. 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):
o

3. 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?
o
If Cost of Goods Sold were 75% of sales?