The Rockafeller Music Company is considering expanding its production line to satisfy the demand for more CDs. The company has commissioned consultant studies for the expansion, spending $200,000 for these studies. The results of the studies indicate that the firm must spend $1 million on a new building and $500,000 on production equipment. The consultants’ report predicts that the company can increase its revenues by $400,000 each year, while incurring an increase of $160,000 in expenses. The consultants expect rivals to step up production within five years, reducing benefits from the expansion to Rockafeller after five years. Therefore, a 5-year time horizon is assumed for this expansion project. The expansion would require that the company increase it currents assets by $100,000 initially, but these asset accounts will be returned to previous levels at the end of the project.
Assume that the building is depreciated using straight-line over a 20-year period and that it can be sold at the end of five years for $800,000. Further assume that the equipment is depreciated using straight-line over a 10-year period and that it can be sold at the end of five years for $150,000. The marginal tax rate of Rockafeller is 40%. The cost of capital for this project is 10%. Should Rockafeller invest in this project? Explain.LO2