FUN Corp. is planning to add a new doll "Lisa" to their production line. Instead of purchasing a third party research report, the marketing department of FUN Corp. conducted their own analysis which saved at least $20,000 for the firm. The assumptions about the expected revenues, expenses and capital investments are presented as the followings. (All numbers are in thousands of US dollars).

Assumptions:

Please assume that the analysis is taking place at the end of Year 0. FUN Corp can undertake this project for 4 years OR for 5 years.

Expected revenues for the next 5 year are:

Year 1 Year 2 Year 3 Year 4 Year 5 (if applicable)

Revenues 10,000 20,000 22,000 15,000 8,000

Cost of goods sold is expected to be 20% of that year's revenue.

Capital investment of machinery is $40,000 and will be paid in 2 equal installments ($20,000 each) at the beginning of Year 1 and Year 2.

The full amount of machinery will be depreciated to zero using a straight-line method over 5 years. FUN Corp. have the option to stop the project and sell the machinery for $10,000 at the end of Year 4. Otherwise, the machinery will be worth nothing ($0) on the market by the end of Year 5.

Net working capital equal to 10% of the following year's projected sales. NWC will be fully recovered by the end of the project (whenever it ends).

If the firm undertakes the doll "Lisa", the free cash flow from existing doll "Amy" is projected to increase by $1,000 in Year 1, $3,000 in Year 2, $3,500 in Year 3 due to better brand recognition.

Corporate income tax rate is 30%. The cost of capital for this project is estimated to be 20%.

Please answer the following questions:

a. What is the NPV of the project if the firm undertakes it for 5 years? What if for 4 years?

b. What is the payback period of the project if the firm undertakes it for 5 years? What if for 4 years?

c. How long would you recommend the firm to undertake this project for? Why?