(Calculating

free cash

flows)

At present, 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. Although you feel there is a50 percent chance you will sell 11,000

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 25 percent chance that you will only sell 2,000 and also a 25 percent chance you will sell 17,000.

The gas skateboards would sell for $110 each and have a variable cost of $45

each. Regardless of how many you sell, the annual fixed costs associated with production would be

$140,000.

In addition, there would be an initial expenditure of $1,200,000

associated with the purchase of new production equipment which will be depreciated using the bonus depreciation method in year 1. Because of the number of stores that will need inventory, the working capital requirements are the same regardless of the level of sales. This project will require a one-time initial investment of $30,000

in net working capital, and working-capital investment will be recovered when the project is shut down. Finally, assume that the firm's marginal tax rate is 24 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, and 2 through 9 under each sales forecast? What are the expected annual free cash flows for year 1, and years 2 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 NPV given a required rate of return of 11 percent? What would the project's NPV be if 11,000 skateboards were sold?