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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

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