Question 1 (20 Marks)

Dunlop Inc. is a sports shoes manufacturer. Having spent $120,000 on market

research, the firm finds a new line of sports shoes promising and considers making

new investments on it. For further evaluation, Dunlop Inc. has gathered the following

investment and operational data for the new sports shoes product line.

New Equipment

It costs $14,000,000.

5 years economically useful life with zero salvage value.

Depreciation is calculated on the straight-line basis.

Net Working Capital (NWC)

Incremental investment in NWC at the beginning of the project is $1,000,000.

New Sports Shoes Product

45,000 pairs of new sports shoes will be sold every year in the next 5 years.

Each pair of new sports shoes will be sold for $700.

Variable cost is $320 per pair. Fixed cost (excluding depreciation) per year is

$7,500,000.

Existing Sports Shoes Product

The launch of new sports shoes product would lower the sales volume of existing

sports shoes product by 13,000 pairs per year in the next 5 years.

Sales price and variable cost for each pair of existing sports shoes product are

$500 and $280 respectively.

2

Required:

(a) Assume 40% corporate tax rate, calculate the amount of initial outlay,

operating cash flow per year and terminal cash flow of the new sports shoes

project. State the total after-tax cash flow for the project from year 0 to year 5.

(17 marks)

(b) Assume 15% required rate of return, should Dunlop Inc. invest in the new

project if the net present value rule is used?

(3 m