Presently, Solartech Skateboards is considering expanding its product line to include gas-powered skateboards; however, it is questionable how well they will be received by skateboarders. While you feel there is a 60 percent chance you will sell 10,000 of these per year for 10 years (after which time this project is expected to shut down because solar-powered skateboards will become more popular), you also recognize that there is a 20 percent chance that you will only sell 3,000 and also a 20 percent chance you will sell 13,000. The gas skateboards would sell for $100 each and have a variable cost of $40 each. Regardless of how many you sell, the annual fixed costs associated with production would be $160,000. In addition, there would be a $1,000,000 initial expenditure associated with the purchase of new production equipment. It is assumed that this initial expenditure will be depreciated using the simplified straight-line method down to zero over 10 years. Because of the number of stores that will need inventory, the working capital requirements are the same regardless of the level of sales, and this project will require a one-time initial investment of $50,000 in net working capital, and that working-capital investment will be recovered when the project is shut down. Finally, assume that the firm’s marginal tax rate is 34 percent.
a. What is the initial outlay associated with the project?
b. What are the annual free cash flows associated with the project for years 1 through 9 under each sales forecast?
What is the expected annual free cash flows for years 1 through 9?
c. What is the terminal cash flow in year 10 (that is, what is the free cash flow in year 10 plus any additional cash flows associated with the termination of the project)?
d. Using the expected free cash flows, what is the project’s NPVgiven a 10 percent required rate of return?
What would the project’s NPVbe if they sold 10,000 skateboards?