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
