BMAN23000(B) MayJune 2013

Johnson Enterprises is evaluating the development of a new product. The new product would generate sales of 1.2, 1.8, 2.4 and 3 million at the end of year 1, 2, 3 and 4, respectively. In addition, it would generate variable costs of 1.1, 1.2, 1.5 and 1.6 million at the end of year 1, 2, 3 and 4, respectively. The project requires an immediate (t=0) investment into R&D of 0.5 million that is not depreciated, and an investment into new equipment of 1 million that is depreciated using the straight-line method. The marginal tax rate is 40% and the effective weighted average cost of capital (WACC) is equal to 10%.

1. a) Create a table showing the calculation of unlevered net income in year 0, 1, 2, 3 and 4. The table MUST show all items required to calculate unlevered net income. (10 marks)
2. b) Johnson Enterprises has already spent 1 million on a feasibility study for the new product. Do they need to consider the 1 million in the EBIT calculations in step a)? Explain. (5 marks)
3. c) Use the unlevered net income created in step i) above to compute free cash flows. Which items do you need to add/subtract to convert net income into cash flow? Explain. (10 marks)
4. d) Using the free cash flows, calculate the NPV of the project. Should the company invest into the new project? Why or why not? (5 marks)
5. e) Although the project above does not require an investment into net working capital, many projects do. How is net working capital defined? Why do you intuitively need to invest into net working capital? Do you recover your net working capital investment? When? (5 marks)