Question
Jocelyn Chen & Bosco Lau Toys has developed a new childrens toy. The project will last for 4years. The total nominal sales for the first
Jocelyn Chen & Bosco Lau Toys has developed a new childrens toy. The project will last for 4years. The total nominal sales for the first year are $20,000 and the annual real growth rate oftotal sales is 20%. Expenses are expected to be 40% of the revenues, and net working capitalrequired in each year is expected to be 20% of the nominal total sales, e.g., for the first year, theexpected nominal total sales is $20,000 so that the level of net working capital for the first year is$20,0000.2=$4000. The product requires an immediate investment of $60,000 in plant andequipment today. The expected nominal salvage value of the plant and equipment at the end of 4years is $23,040. In addition, the firm spent $15,000 on developing and designing the new toylast year. There are no other opportunity costs for this project.Plant and equipment can be depreciated at 20% per year. The company has many other assets inthis asset class so that the asset class remains open after the termination of the project. Thecorporate tax rate is 40% and the nominal annual discount rate for all cash flows is 12%.
7.1 What is the projects NPV if the annual inflation rate is 0% for the duration of this project?Since inflation rate is 0, there is no difference between numbers quoted in real term and numbersquoted in nominal term.
7.2 What is the projects NPV if the following assumptions are changed all together?i) the nominal salvage value of the plant and equipment at the end of year 4 is now $80,000;ii) the annual inflation rate for these 4 years is now 4%;iii) the asset class now terminates after the sales of assets at the end of year 4.
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