$24$

$1$ point

A company wants to add a manufacturing machine to an existing factory to accommodate rising demand for their product. The factory is close to its effective capacity now, so the new machine will support sales which are expected to grow linearly during the next four years, topping out at $$2,000,000$ for years $4$ and $5.$ Sales for each year are forecasted to be:

Year $1$: $$1,000,000$

Year $2$: $$1,500,000$

Year $3$:$$2,000,000$

Year $4$: $$2,000,000$

Year $5$: $$2,000,000$

Cash operating costs will be $65\%$ of revenue for each year.

The machine has an installed cost of $$2$ million, and will be depreciated straightline over $5$ years assuming a $10\%$ salvage value. The salvage amount will also be included as part of the terminal value, representing the amount recaptured at the end of year $5.$ There will be no tax effect in the salvage value because the book value is expected to be $10\%$ of the historical cost at the end of year $5.$

There will be no need for additional net working capital in the initial investment, but the need for net working capital will grow in proportion to sales growth. When capacity tops out at the end of year $4,$ the total net working capital will become $$60,000.$ This amount will be released in the final year as part of the terminal value.

The company's WACC $($weighted average cost of capital$)$ is $11\%,$ so this will be the required rate of return for this expansion. They also would like a $24-$month payback period so that capital will become available for other projects. They are subject to a $25\%$ tax rate.

Evaluate the project based on the criteria of net present value, internal rate of return and pay back period and indicate the correct responses below.

Choose all responses which are correct

The project has an Internal Rate of Return less than the required rate

The project has a positive Net Present Value

The project should not be moved forward in the approval process

The project has a Pay Back Period longer than desired

The project has a Pay Back Period shorter than des$$red

The project has a Internal Rate of Return higher than the required rate

The project has a negative Net Present Value

The project should be moved forward in the approval process