Landcruisers Plus LP has operated an online retail store sel

Landcruisers Plus? (LP) has operated an online retail store selling? off-road truck parts. As the name? implies, the firm specializes in parts for the venerable Toyota FJ40 that is known throughout the world for its durability and offroad prowess. The fact that Toyota stopped building and exporting the FJ40 to the U.S. market in 1982 meant that FJ40 owners depended more and more on? re-manufactured parts to keep their beloved? off-road vehicles running. More and more FJ40 owners are replacing the original inline? six-cylinder engines with a modern? American-built engine. The engine replacement requires mating the new engine with the Toyota drive train.

?LP\'s owners had been offering engine adaptor kits for some time but have recently decided to begin building their own units. To make the adaptor kits the firm would need to invest in a variety of machine tools costing a total of $650,000. LP\'s management estimates that they will be able to borrow $300,000 from the? firm\'s bank and pay 8 percent interest. The remaining funds would have to be supplied by? LP\'s owners.The firm estimates that they will be able to sell? 1,000 units a year for $1,300 each. The units would cost $1,000 each in cash expenses to produce? (this does not include depreciation expense of $65,000 per year or interest expense of $24,000?). After all? expenses, the firm expects earnings before interest and taxes of $235,000. The firm pays taxes equal to 36 percent, which results in net income of $126,400 per year over the 10-year expected life of the equipment.   

a.??What is the annual free cash flow LP should expect to receive from the investment in year 1 assuming that it does not require any other investments in either capital equipment or working capital and the equipment is depreciated over a 10?-year life to a zero salvage and book? value? How should the financing cost associated with the $300,000 loan be incorporated into the analysis of cash? flow?

b.??If the? firm\'s required rate of return for its investments is 8 percent and the investment has a 10?-year expected? life, what is the anticipated NPV of the? investment?

c) The financing cost associated with the 300,000 loan should or should not be incorporated into the analysis of cash flow?

Solution

a) Free cash flow from project = 126400+65000 191400 The financing cost associated with the loan would be deducted while analysing the cash flow b) Year Cash flow Discount factor @ 8% 0 -650000 1 -650000 1 215400 0.925926 199444.4 2 215400 0.857339 184670.8 3 215400 0.793832 170991.5 4 215400 0.73503 158325.4 5 215400 0.680583 146597.6 6 215400 0.63017 135738.5 7 215400 0.58349 125683.8 8 215400 0.540269 116373.9 9 215400 0.500249 107753.6 10 215400 0.463193 99771.88 Net Present Value 795351.5 Cash flow from projects Sales 1300000 Less : Cash Expense -1000000 300000 Less: Depreciation -65000 235000 Less : Tax @36% 84600 150400 Add: Depreciation 65000 215400 c) The financing cost should not be incorporated into the analysis of cash flow while calculating NPV