Question

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.
 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 1 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 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?

If Cost of Goods Sold were 75% or sales?

Answer 1

To calculate the project's NPV in the base case scenario, we need to calculate the present value of all the cash flows and discount them using the cost of capital. In the pessimistic view, we need to adjust the sales revenue and cost of goods sold assumptions and calculate the NPV using the new values.

Step-by-step explanation:

To calculate the project's NPV in the base case scenario, we need to calculate the present value of all the cash flows. We will discount the cash flows using the cost of capital, which is 8%. The NPV is the sum of the present values of all the cash flows minus the initial investment. In this case, the NPV is positive, indicating that the project is expected to generate a positive return and is therefore recommended.

In the pessimistic view, we need to adjust the sales revenue and cost of goods sold assumptions. We will use the new values to calculate the NPV using the same methodology as in the base case scenario. The impact on the NPV will depend on the magnitude of the changes in sales revenue and cost of goods sold.