Petracci SpA manufactures fine furniture. The company is deciding whether to introduce a new mahogany dining room table set. The set will sell for

€5,600, including a set of eight chairs. The company feels that sales will be 1,300, 1,325, 1,375, 1,450 and 1,320 sets per year for the next 5 years, respectively. Variable costs will amount to 45 per cent of sales, and fixed costs are €1.7 million per year. The new tables will require inventory amounting to 10 per cent of sales, produced and stockpiled in the year prior to sales. It is believed that the addition of the new table will cause a loss of 200 tables per year of the oak tables the company produces. These tables sell for €4,500 and have variable costs of 40 per cent of sales. The inventory for this oak table is also 10 per cent. Petracci currently has excess production capacity. If the company buys the necessary equipment today, it will cost €10.5 million. However, the excess production capacity means the company can produce the new table without buying the new equipment. The company controller has said that the current excess capacity will end in 2 years with current production. This means that if the company uses the current excess capacity for the new table, it will be forced to spend the

€10.5 million in 2 years to accommodate the increased sales of its current products. In 5 years, the new equipment will have a market value of €2.8 million if purchased today, and

€6.1 million if purchased in 2 years. The equipment is depreciated using reducing balances at 20 per cent per annum. The company has a tax rate of 38 per cent, and the required return for the project is 14 per cent.

(a) Should Petracci undertake the new project?

(b) Can you perform an IRR analysis on this project? How many IRRs would you expect to find?

(c) How would you interpret the profitability index?