Question

ModernBikes (MB) projects sales for a new off-road bicycle:

Year Projected number of units sold

1 85.000

2 98.000

3 106.000

4 114.000

5 93.000

Operating net working capital is estimated to be 15% of the projected sales the following year. You

can assume that net working capital is fully recovered after 5 years. Total fixed costs are €900,000

per year, variable production costs are €240 per unit, and the estimated sales price is €325 per unit.

The investment cost is €20,000,000, which will be depreciated over five years using straight-line

depreciation. At the end of year 5, this equipment can be sold for 20% of its acquisition cost (before

tax). MB pays 35% in corporate taxes and uses 9% required rate of return on all its projects.

Based on these project estimates, what is the NPV of the project? What is the internal rate of return

for the project? Should MB implement the project?

Answer 1

1)		0	1	2	3	4	5
	Sales in number of units		85000	98000	106000	114000	93000
	Sales dollars		27625000	31850000	34450000	37050000	30225000
	Variable cost		20400000	23520000	25440000	27360000	22320000
	Fixed cost		900000	900000	900000	900000	900000
	Depreciation (20000000/5)		4000000	4000000	4000000	4000000	4000000
	NOI		2325000	3430000	4110000	4790000	3005000
	Tax at 35%		813750	1200500	1438500	1676500	1051750
	NOPAT		1511250	2229500	2671500	3113500	1953250
	AddL Depreciation		4000000	4000000	4000000	4000000	4000000
	OCF		5511250	6229500	6671500	7113500	5953250
	Capital expenditure	20000000
	Increase in NWC	4143750	633750	390000	390000	-1023750	-4533750
	After tax salvage value (4000000*65%)						-2600000
	Annual project cash flows	-24143750	4877500	5839500	6281500	8137250	13087000
	PVIF at 9%	1	0.91743	0.84168	0.77218	0.70843	0.64993
	PV at 9%	-24143750	4474771	4914990	4850471	5764633.05	8505652.1
	NPV	4366767
2)	IRR is that discount rate for which NPV = 0. It has to be found out by trial and error. Different interest rates are to be
	used till 0 NPV is reached.							NPV
	Annual project cash flows	-24143750	4877500	5839500	6281500	8137250	13087000
	Discounting with 15%
	PVIF at 15%	1	0.86957	0.75614	0.65752	0.57175	0.49718
	PV at 15%	-24143750	4241304	4415501	4130188	4652499	6506552	-197705
	Discounting with 14%
	PVIF at 14%	1	0.87719	0.76947	0.67497	0.59208	0.51937
	PV at 14%	-24143750	4278509	4493306	4239834	4817905	6796978	482781
	IRR lies between 14% and 15% as NPV is positive with 14% and negative with 15%.
	The value of IRR, by simple interpolation of NPV with change in interest rates =((14+482781/(482781+197705)) =							14.71%
	DECISION:
	The project can be implemented as the NPV is positive.