 Goodweek predicts that the Super Tread will be on the market for four years.

Research and development expenditures and test marketing are sunk costs, which
means they will not affect the project's cash flow.
THE CALCULATION OF CASH FLOW
Equipment cost: Goodweek must initially invest $160 million in production equipment
to make the Super Tread. This equipment can be sold for $65 million at the end of four
years.
Depreciation cost: Modified Accelerated Cost Recovery System (MACRS) method has
been used in calculating the depreciation. According to the seven-year MACRS
depreciation schedule and the initial investment, the depreciation of each year is:
Year 1: Depreciation= 160M × 0.1429 = 22.864M
Year 2: Depreciation= 160M × 0.2449 = 39.184M
Year 3: Depreciation= 160M × 0.1749 = 27.984M
Year 4: Depreciation= 160M × 0.1249 =19.984M
Year MACRS% Depreciation Book Value
1 0.1429 22.864 137.136
2 0.2449 39.184 97.952
3 0.1749 27.984 69.968
4 0.1249 19.984 49.984
5 0.0893 14.288 35.696
6 0.0892 14.272 21.424
7 0.0893 14.288 7.136
8 0.0446 7.136 0

We compute the OCF based on the data, which includes sales, expenses, and depreciation.
We can compute the Sales and Costs given the data of unit pricing, sales volume, market
growth rate, and inflation rate.
REVENUE AND VARIABLE COST:
Sales of the OME market:
Year 1: Sales= 41 × 6.2M × 4 × 11% = 111.848M
Year 2: Sales= 41 × 6.2M × 4 × 11% × (1+1%)(1+3.25%) × (1+2.5%) =119.54M
Year 3: Sales= 41 × 6.2M × 4 × 11% × (1+1%)2 (1+3.25%)2 × (1+2.5%)2 = 127.77M
Year 4: Sales= 41 × 6.2M × 4 × 11% × (1+1%)3(1+3.25%)3 × (1+2.5%)3 = 136.57M
Costs of the OME markets:
Year 1: Costs= 29 × 6.2M × 4 × 11% =79.112M
Year 2: Costs= 29 × 6.2M × 4 × 11% × (1+1%)(1+3.25%) × (1+2.5%) = 84.56M
Year 3: Costs= 29 × 6.2M × 4 × 11% × (1+1%)2 (1+3.25%)2 × (1+2.5%)2 = 90.38M
 Year 4: Costs= 29 × 6.2M × 4 × 11% × (1+1%)3(1+3.25%)3 × (1+2.5%)3 = 96.61M
Year 1 2 3 4
Sale unit 2.56 2.61 2.66 2.71
Price 62 64.65 67.42 70.31
Sales revenue 158.72 168.81 179.56 191.01
Variable cost/unit 29 30.23 31.51 32.85
Variable cost 74.24 78.94 83.94 89.26

TOTAL REVENUE AND VARIABLE COST

Year 1 2 3 4
Sale revenue 270.568 288.351 307.339 327.586
Variable cost 153.352 163.530 174.385 185.961

Capital gain on salvage value: Corporate tax will apply to capital gain. Salvage value will
be adjusted for tax on capital gains.
Salvage value 65
Book value (at the end of four years) 49.984
Capital gain 15.016
Tax on capital gain (=40%) 6.0064
After tax capital gain 58.9936

 The OCF of the Goodweek Tires is:

Net Present Value (NPV): NPV of the project refer to total present value (PV) of future cash
flow + initial investment. Estimating NPV need to:
• Estimate timing and amount of future cash flows
• Discount rate
• And estimate initial cost
An acceptance criterion is: Accept if NPV > 0.
In this case we have used 13.4% as the discount rate. Using the worksheet we get the OCF is:
Year 1 2 3 4
Sae revenue 270.57 288.29 307.18 327.30
Variable cost 153.35 163.53 174.38 185.96
Marketing cost 43.00 44.40 45.84 47.33
Depreciation 22.86 39.18 27.98 19.98
Income 51.35 41.18 58.97 74.03
Taxes 20.54 16.47 23.59 29.61
Net income 30.81 24.71 35.38 44.42
OCF 53.68 63.89 63.37 64.40

Using the worksheet we get the NPV is:

 Year 0 1 2 3 4
Sae revenue 270.57 288.29 307.18 327.30
Variable cost 153.35 163.53 174.38 185.96
Marketing cost 43.00 44.40 45.84 47.33
Depreciation 22.86 39.18 27.98 19.98
Income 51.35 41.18 58.97 74.03
Taxes 20.54 16.47 23.59 29.61
Net income 30.81 24.71 35.38 44.42
OCF 53.68 63.89 63.37 64.40
Initial
-160.00
investment
NWC 9.00 9.00 40.59 43.24 46.08
Change in
-9.00 -31.59 -2.66 -2.83 0.00
NWC
Salvage value 65.00
Salvage value
after capital 58.99
gain
Cash flow -169.00 22.09 61.23 60.53 169.47
Discounted CF -169.00 19.48 47.62 41.51 102.48
NPV= -169 + 19.4 8+ 47.26 + 41.51 + 102.4 8= 42.09 > 0
Note: if the project NPV is positive, we will accept the project
Payback Periods: This refer to the amount of time (in years, month, etc) required to recover
the initial cost.
Year 1 2 3 4
Opening balance
169 146.91 85.68 25.14
new product
Cash flow 22.09 61.23 60.53 169.47
Ending balance 146.91 85.68 25.14 -144.33

Pay back period of the new product will be: 2 + (25.14/169.47)=3.14 years
Discounted payback period: this method accounts for the time value by discounting the
cash flows by the discount rate.
Year 1 2 3 4
Opening balance
169 146.91 101.90 60.39
new product
Cash flow 19.48 47.62 41.51 102.48
Ending balance 149.52 101.90 60.39 -42.09

The discounted payback period of this new product will be: 3 + (60.39/102.48) = 3.58 years
The Internal Rate of Return (IRR) is the discount rate that causes NPV to equal zero.
Minimum acceptance criteria: accept if the IRR exceeds the necessary return (R). Ranking
criteria: Choose the alternative with the highest IRR. Reinvested Assumption: All future cash
flows are assumed to be reinvested at IRR. IRR and NPV may not always rank the same.
Accept the project if the IRR exceeds the discount rate.
0= -169 + 22.09/IRR + 61.23/IRR2+ 60.53/IRR3 + 169.47/IRR4
 IRR= 22.02%
Note: As the IRR is bigger than the discount rate (13.4%). The project should be undertaken.
Profitability Index (PI): total present value of project inflows divided by the initial investment.
Ranking criteria: select project with the highest PI
Minimum acceptance criteria: Accept if PI > 1, NPV> 0
Probability Index
Discounted cash 19.48 47.62 41.51 102.48
Total discounted cash 211.09
Initial investment 169.00
PI 1.25
As the PI of the project is bigger than 1, the project will be acceptable.
RESULT
Result
NPV 42.09
Payback period 3.14 years
Discounted payback period 3.58 years
IRR 22.02%
PI 1.25
 As a result, we should accept the project.