Barrett Ltd is considering developing a new product. Barrett already spent $150m in research and development last year. In order to continue with the project, Barrett would have to acquire specialized machinery at a cost of $600m, payable in two equal installments at time 0 and time 1. At time 0, the full value of the machinery is written on the book as a fixed asset, and the future payment due at time 1 is temporarily recorded as a current liability. At time 1, the second installment is paid and the current liability goes away. The machine depreciates to zero in straight line over 4 years, and it can be sold in year 4 for $100m.
Product sales are predicted to be $500m in year 1, declining at a rate of 20%. The cost of producing the product has a fixed components equal to $100m/year and a variable component equal to 30% of sales. Barrett’s tax rate is 25%. There is no interest expense.
a. Calculate net income in each year from 0 to 4, including any capital gains or losses
b. Calculate the change in net working capital in every year.
c. Calculate the change in net fixed assets in every year
d.Calculate the project’s free cash flow
e. Barrett’s discount rate is 11%. What is the project’s NPV?