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The terms highlighted in Bold have direct connection to lecture material in Topic 1.
A company is investigating a possibility of introducing a production of a new gadget. The
company expects that it will be able to charge a relatively higher price per unit in earlier years by
limiting supply of the gadget and due to the lack of competition, while it expects the price to
drop in later years due to ramped up supply and more competition on the market. The table
below shows the expected sales and prices for each year.

Year Unit Sales Unit Price

1 3,000 $100

2 4,000 $100

3 5,000 $90

4 6,000 $90

5 7,000 $80

6 8,000 $80

7 8,000 $75

8 8,000 $75

The production of the gadget is expected to last for 8 years and fully stop after that. Initially, this
project will require $25,000 in net working capital at the very start. Subsequently, net working
capital is estimated to be equal to 15% of sales for that year. Annual fixed costs of producing the
gadget are $50,000 and variable costs are $25 per unit. The equipment required to begin and
maintain the production line costs $1,000,000 to design and build. At the end of the project’s life,
the equipment will be worth 25% of its initial cost. The relevant tax rate is 34%.

1) Based on the information above, compute the projected annual cash flows.

2) The company chooses to take on debt and finance 20% of the initial cost of designing and
building the equipment with an 8-year, 8% interest-only loan. Compute the projected annual cash
flows given the debt and its repayment.