Private cars is a medium size car manufacturer planning to starta new business of sports cars.
As part of Initial investment, the firm needs to purchasemanufacturing equipment worth $ 10 million today and also incur anadditional R&D cost of $ 2 million.
The equipment will be depreciated in equal amounts over the next10 years.
In the first year, the firm expects to sell 100 cars at $ 25,000each and the manufacturing cost is estimated to be $ 15,000 percar.
As demand rises and processes are streamlined, the firm expectsrevenues to grow by 7% each year for the first 10 years and remainconstant from the 11thyear onwards into the indefinitefuture
Over the same period, cost of manufacturing is expected to riseby only 2% per year and stabilize from the 11thyearonwards.
Note: The project doesn’t terminate in 10 years butcontinues into the indefinite future
To guard against contingencies, the firm needs to set aside $ 3million at the start of the project. However, as the projectdevelops, the contingency amount can be reducedby $300,000 each year.
From the 11thyear onwards, the firm does not envisagebuying or selling off any additional equipment or incurring anycosts beyond the cost of manufacturing the cars.
To fund the project the firm borrows $ 5 million from the bankwhich charges an interest rate of 4%. The loan will need to berepaid in equal-sized annual instalments over 10 years, starting inYear 1.
The rest of the funding comes from shareholders who expect an 8%return on their investment.
The corporate tax rate is 40% and expected to remainconstant.
Calculate the NPV of the project.
