You have been given the following information on a project.

The project has a five-year life time. The initial investment in the project will be $25 million, and the investment will be depreciated straight-line, down to salvage value of $10 million at the end of the fifth year.

The revenues are expected to be $20 million next year and to grow 10% a year after that for the remaining four years. The cost of goods sold, excluding depreciation, is expected to be 50% of revenues.

The tax rate is 30%. The firm faced cost of capital of 14%.

Questions:

1. Compute:

Calculate Free Cash flow over the projects life.

Calculate terminal year cash flow for the project.

Should the project be accepted using NPV analysis.

Now assume that the facts in problem 1 remain unchanged except for the depreciation method which is now according to the following table. In this case the salvage value will be whatever is left at the end of year 5.

Year % of Asset

1

40%

2

24%

3

14.4%

4

13.3%

5

13.3%

2. If the firm has a cost of capital of 14%

a. should it take the project using NPV analysis.

b. Compare NPV calculated in Question 1 with NPV calculated in Question 2. In which case the NPV is higher? Why do you see this difference?

3. Perform a sensitivity analysis on NPV of the project for (1) on the following scenarios:

a. Sales decreases by 10%.

b. Cost of capital decreases by 10%.

c. Both (a) and (b).