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Ray's Racks, a company that develops and manufactures bike racks and locks, has developed a new, highly Simplified bike lock. It can go into production for an initial investment in equipment of $5.7 million. The equipment will be depreciated straight line over 6 years to a value of zero, but in fact it can be sold after 6 years for $671,000. The firm estimates production costs of $1.80 per lock and believes that the locks can be sold for 58 each. The firm believes that working capital (primarily for spare parts) must be maintained at a level of 10% of next year's forecast sales. The project will come to an end in 6 years, when the lock becomes technologically obsolete. The firm's tax bracket is 35%. This project is considered to be an average risk project for Ray's Racks. Sales volume forecasts (number of locks sold) are given in the following table. Year 0 1 2 3 4 5 6 Thereafter Sales (locks) O 400,000 500,000 700,000 700,000 500,000 300,000 1. What are annual operating and total cash flows (show in CF model below)? 2. Assuming a discount rate of 18% what is the project PV? 3. What is the project NPV? 4. Based on the NPV rule, should the project be accepted? 5. What is the project IRR? 6. Based on the IRR rule, should the project be accepted? Show transcribed image text Expert Answer Anonymous answered this 7,256 answers Was this answer helpful? 5 Year Sales (locks) Revenue Cost of production Depreciation PBT Tax @ 35% PAT Add: Depreciation WC Less: increase in WC Add: Salvage value Less: tax on salvage Less: investment Free Cash Flow PV @ 18% PV 1 400000 3200000 720000 950000 1530000 535500 994500 950000 400000 80000 2 500000 4000000 900000 950000 2150000 752500 1397500 950000 560000 160000 3 700000 5600000 1260000 950000 3390000 1186500 2203500 950000 560000 0 700000 5600000 1260000 950000 3390000 1186500 2203500 950000 400000 -160000 500000 4000000 900000 950000 2150000 752500 1397500 950000 240000 -160000 300000 2400000 540000 950000 910000 318500 591500 950000 0 -240000 671000 234850 320000 320000 5700000 -6020000 1864500 1580085 2187500 1571028 3153500 1919317 3313500 1709066 2507500 2217650 1096051 821488 8697036 NPV @ 18% 2677036 Since NPV is positive, project should be accepted IRR 33.16% Since IRR more than 18%, project should be accepted

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