You have developed a new a new recreational tennis racket with tennis great Jimmy Connors. You have paid Jimmy Connors for his involvement in the project $250,000. The racket is state of the art and guaranteed to correct any backhand. You now need to decide if you want to proceed with mass marketing of this racket. You estimate the sales price of the new racket to be $400 per racket and sales volume to be 1,000 units in year 1, 1,250 units in year 2; and 1,325 units in year 3. The project has a three year life. Variable costs amount to $225 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $165,000 in assets which will be depreciated straight line to zero over the three year project life. The actual market value of these assets at the end of year three is expected to be $35,000. NWC requirements at the beginning of each year will be 20 percent of the projected sales during the coming year. The tax rate is 34 percent and the required return on the project is 10 percent.
a) What will the annual incremental cash flows for the project be?
b) Using NPV analysis should the project be undertaken? Explain.