NPV of the Project Assignment | Homework For You
Private cars is a medium size car manufacturer planning to start a new business of sports cars.
As part of Initial investment, the firm needs to purchase manufacturing equipment worth $ 10 million today and also incur an additional R&D cost of $ 2 million.
The equipment will be depreciated in equal amounts over the next 10 years.
In the first year, the firm expects to sell 100 cars at $ 25,000 each and the manufacturing cost is estimated to be $ 15,000 per car.
As demand rises and processes are streamlined, the firm expects revenues to grow by 7% each year for the first 10 years and remain constant from the 11thyear onwards into the indefinite future
Over the same period, cost of manufacturing is expected to rise by only 2% per year and stabilize from the 11thyear onwards.
Note: The project doesn’t terminate in 10 years but continues into the indefinite future
To guard against contingencies, the firm needs to set aside $ 3 million at the start of the project. However, as the project develops, the contingency amount can be reduced by $ 300,000 each year.
From the 11thyear onwards, the firm does not envisage buying or selling off any additional equipment or incurring any costs beyond the cost of manufacturing the cars.
To fund the project the firm borrows $ 5 million from the bank which charges an interest rate of 4%. The loan will need to be repaid in equal-sized annual instalments over 10 years, starting in Year 1.
The rest of the funding comes from shareholders who expect an 8% return on their investment.
The corporate tax rate is 40% and expected to remain constant.
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