Assignment:
PLI produces unusual gifts targeted at wealthy consumers. The company is analyzing the possibility of introducing a new device designed to attach to the collar of a cat or dog. This device emits sonic waves that neutralize airplane engine noise, so that pets traveling with their owners will enjoy a more peaceful ride. PLI believes that developing this project will require up-front capital expenditure of $10 M. These costs will be depreciated on a straight-line basis for 5 years.
PLI believes that it can sell the product initially for $250. The selling price will increase to $260 in years 2 and 3 before falling to $245 and $240 in years 4 and 5, respectively. After 5 years the company will withdraw the product from the market and replace it with something else. Variable costs are $135 per unit. PLI forecasts sales volume of 20,000 units per year, with increase of 25% in year 2, 20% in year 3, 20% in year 4 and 15% in year 5. Offering this product will force PLI to make additional investments in receivables and inventory. Projected end-of-year balances appear in the table.
|
|
Year 0
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Year 1
|
Year 2
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Year 3
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Year 4
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Year 5
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Acc. Receivable
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$0
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$200,000
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$250,000
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$300,000
|
$150,000
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$0
|
|
Inventory
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0
|
500,000
|
650,000
|
780,000
|
600,000
|
0
|
The firm faces a tax rate of 34%. Assume that cash flows arrive at the end of each year, except for the initial $10 M outlay.
a) Compute the projects cash flows each year.
b) Compute two NPVs one using 10% discount rate and one using 15%.
c) A PLI financial analyst reasons as follows: "With the exception of the initial outlay, the cash flows of this project arrive in more or less a continuous stream rather than at the end of each year. Therefore, by discounting each year's cash flows flow for a full year, we are underestimating the true NPV. A better approximation is to move the discounting 6 months forward - i.e. discount the year-1 cash flow for 6 months, year-2 cash flow for 1.5 years, and so on - this assumption implies that cash flows take place in the middle of the year instead of at the end of the year." Re-compute the NPVs. Does it make any difference? Explain.