Question
6. XYZ Corporation, a firm in the 34% tax bracket with a 12% required rate of return (discount rate), is considering a new project. This
6. XYZ Corporation, a firm in the 34% tax bracket with a 12% required rate of return (discount rate), is considering a new project. This project involved the introduction of a new product. This project is expected to last 5 years and then the product line will be terminated. Given the following information, determine the free cash flows associated with the project (tabulate your answer on a year by year basis), the projects net present value and the profitability index. Apply the appropriate decision criteria.
Cost of new plant and equipment: $6,900,000 Shipping and installation costs: $100,000 Salvage Value at termination: $50,000
Year | Unit Sold |
1 | 80,000 |
2 | 100,000 |
3 | 120,000 |
4 | 70,000 |
5 | 70,000 |
Sales price per unit: $190/unit in year 1-4, $250/unit in year 5 Variable cost per unit: $130/unit Annual fixed costs: $300,000
Working capital requirements: There will be an initial working capital requirement of $150000just to get production started. For each year, the total investment in net working capital will equal 5% of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5.
The depreciation method: Use the simplified straight-line method over 5 years. It is assumed that the plant and equipment will have no salvage value after 5 years.
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