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The company CoolCar is a car manufacturer. It is considering producing a new model of electric cars. This project requires an initial investment of £15 million. The project will last for 3 years and the relevant producing equipment can be depreciated straight line over the project period. At the end of the project (year 3), the equipment can be sold at a price of £4 million. The tax rate of asset sales is the same as that for the firm’s operating income.
Given the analysis by the marketing team, the target sale price of this new electric car is £50,000. The cost of each car is £45,000. The demand in the first year is expected to be 1,500 cars. The growth rate of the demand is expected to be 10% in each of the remaining two years. Assume the sale price and the cost to be constant. This project requires relevant working capitals. According to its operating experiences, CoolCar needs 10% of the sales as working capital in each year of the project. The firm is in the 25% tax bracket and its cost of capital is 10%.
Required:
i. Calculate the changes in Net Working Capital in each year of the CoolCar’s project.
[5 marks]
ii. At the end of this 3-year project, what is the book value of the producing equipment and what is the after-tax gain on the sale of the equipment?
[5 marks]
iii. Calculate the NPV of this 3-year project.
[25 marks]
iv. An alternative project plan is to produce the new electric cars for 4 years (i.e. one-year extension to the original plan). The demand for the electric cars in year 4 is expected to shrink compared to the demand in year 3. Assume the demand in year 4 is the same as that in year 1, i.e. 1,500 cars. The residual value of the producing equipment will be zero at the end of year 4. The straight-line depreciation rule applied to the 4-year period.
Please calculate the NPV of this alternative project. Would you recommend the 3-year project or the 4-year project?
[15 marks]
