Kane Running Shoes is considering the manufacture of a special shoe for race walking, which

will indicate if an athlete is running (that is, both legs are not touching the ground). The chief

economist of the company presented the following calculation for the Smart Walking Shoe

(SWS):

R&D: $200,000 annually in each of the next four years

For the manufacturing project:

Expected life span: ten years

Investment in machinery: $250,000 (at t=4) expected life span of the machine ten years

Expected annual sales: 5,000 pairs of shoes at the expected price of $150 per pair

Fixed cost: $300,000 annually

Variable cost: $50 per pair of shoes

Kane's discount rate is 12%, the corporate tax rate is 40%, and R&D expenses are tax deductible

against other profits of the company. Assume that at the end of project (that is, after fourteen

years) the new technology will have been superseded by other technologies and therefore will

have no value.

(a)What is the NPV of the project?

(b)The International Olympic Committee (IOC) decided to give Kane a loan without interest

for six years in order to encourage the company to take on the project. The loan will have

to be paid back in six equal annual payments. What is the minimum loan that the IOC should

give in order that the project will be profitable?

20. (Continuation of previous problem) After long negotiations, the IOC decided to lend Kane

$600,000 at t=0. The project went ahead. After the research and development stage was com-

pleted (at t=4) but before the investment was made, the IOC decided to cancel race walking as

an Olympic event. As a result, Kane is expecting a large drop in sales of the SWS shoes. What is

the minimum number of shoes Kane has to sell annually for the project to be profitable in each

of the following two cases:

(a)If, in the event of cancellation, the original loan term continues?

(b)If, in the event of cancellation, the company has to return the outstanding debt to the IOC

immediately?