Problem 12.5: You are considering adding new elliptical trainers to your firm's product line of fitness equipment, and you feel the firm can sell 7,500 of these per year for five years (after which time this project is expected to shut down when there are new technologies used to stay healthy. Each elliptical trainer would have variable costs of $650, and increase by inflation each year for years 2 thru 5. The elliptical trainers will sell for $1,300 in years 1 and 2, and $1,200 in years 3 thru 5; annual fixed costs associated with production would be $1,425,000 for year 1 and increase by inflation each year for years 2 thru 5. In addition, there would be a $7,500,000 initial expenditure associated with the purchase of new production equipment. It is assumed that the simplified straight-line method would be used to depreciate this initial expenditure down to zero over five years. This project will also require a one-time initial investment of $1,500,000 in net working capital associated with inventory, and this working capital investment will be recovered when the project is shut down. Additionally, the introduction of the new elliptical trainers will have a negative impact on the sales of their existing elliptical trainers by 750 units each year. These existing trainers have a unit sales price of $900 and a variable unit cost of $500 for year 1, and increase by inflation each year for years 2 thru 5. Assume an inflation rate of 3.0%. Finally, the firm's tax rate is 24 percent. a. What is the initial cash outlay associated with this project? b. What are the annual net cash flows associated with this project for years 1-4? c. What is the terminal cash flow in year 5 (that is, what is the free cash flow in year 5 plus any additional cash flows associated with the termination of the project?) d. What is the projects NPV given a 9% required rate of return? B 4 5 6 INPUTS: Tax Rate Required Rate of Return Years Cost of the New Equipment 7 Initial Working Capital 8 Inflation rate 29 30 Year B1 Units Sold 32 Unit Sale Price 33 Variable Cost/Unit 34 Reduced Existing Units 35 Existing Unit Sales Price 36 Existing Unit Variable cost 37 Annual Fixed Cost 38 Depreciation Rate 39 40 Step 1: Calculate Net Operating Cash Flows 41 42 Sales Revenue Variable Costs 43 Sales Revenue - Existing 44 Variable Costs - Existing 45 Fixed costs 46 Depreciation 47 Net Operating Income 48 Less: Taxes 49 Operating income after taxes 0 1 2 3 5