You are evaluating the HomeNet project under the following assumptions: Sales of 50,000

units in year 1 increasing by 47,000

units per year over the life of the project, a year 1 sales price of $260/unit,

decreasing by 10%

annually and a year 1 cost of $120/unit decreasing by 21%

annually. In addition, new tax laws allow you to depreciate the equipment, costing $7.5

million, over three years using straight-line depreciation. Research and development expenditures total $15 million in year 0 and selling, general, and administrative expenses are $2.8 million per year (assuming there is no cannibalization).

Also assume HomeNet will have no incremental cash or inventory requirements (products will be shipped directly from the contract manufacturer to customers). However, receivables related to HomeNet are expected to account for 15%

of annual sales, and payables are expected to be 15%

of the annual cost of goods sold. Under these assumptions the unlevered net income, net working capital requirements and free cash flow are shown in the Table

.

HomeNet		0	1		2	3	4 5
	Units Sales (000s)	47		50	97	144	191	-
	Sales Price ($/unit)	10%		260	234.00	210.60	189.54
	Cost of Goods Sold ($/unit)	21%		120	94.80	74.89	59.16	-
	Operating Expenses ($000s)							-
	Hardware & Software Develop.		(15,000)					-
	Marketing & Technical Support			(2,800)	(2,800)	(2,800)	(2,800)	-
	Capital Expenditures							-
	Lab Equipment		(7,500)					-
	Depreciation			33%	33%	33%	-	-
	Marginal Corporate Tax Rate		40%	40%	40%	40%	40%	-

	Year	0	1	2	3	4	5
Incremental Earnings Forecast ($000)
1	Sales	-	13,000	22,698	30,326	36,202	-
2	Cost of Goods Sold	-	(6,000)	(9,196)	(10,784)	(11,300)	-
3	Gross Profits	-	7,000	13,502	19,542	24,902	-
4	Selling, General, and Administrative	-	(2,800)	(2,800)	(2,800)	(2,800)	-
5	Research and Development	(15,000)	-	-	-	-	-
6	Depreciation	-	(2,500)	(2,500)	(2,500)	-	-
7	EBIT	(15,000)	1,700	8,202	14,242	22,102	-
8	Income Tax at 40%	6,000	(680)	(3,281)	(5,697)	(8,841)	-
9	Unlevered Net Income	(9,000)	1,020	4,921	8,545	13,261	-
Free Cash Flow ($000)
10	Plus: Depreciation	-	2,500	2,500	2,500	-	-
11	Less: Capital Expenditures	(7,500)	-	-	-	-	-
12	Less: Increases in NWC		(1,050)	(976)	(905)	(804)
13	Free Cash Flow	(16,500)	2,470	6,445	10,140	12,457	3,735

Using the FCF projections given:

a. Calculate the NPV of the HomeNet project assuming a cost of capital of

10%, 12% and 14%.

b. What is the IRR of the project in this case?