a. b. C. Problem 1 Regency Integrated Chips (RIC), a large Nashville-based technology company is evaluating a new project to manufacture a new chip. The project's estimated economic life is 5 years. RIC's marketing vice-president believes that annual sales would be 30,000 units if the units were priced at $6,000 each. RIC expects no growth in unit sales, and it believes that the unit price will rise by 3 percent each year. The engineering department has reported that the project will require additional manufacturing space, and RIC currently has an option to purchase an existing building, at a cost of $20 million, which would meet this need. The building would be bought and paid for on December 31 of Year 0, and for depreciation purposes, it would fall into the MACRS 39-year class. The annual depreciation rate for the five years of economic life of the project would be: Year 1 Year 2 Year 3 Year 4 1.3% 2.6% 2.6% 2.6% Year 5 2.6% d. The necessary equipment would be purchased, installed, and paid for on December 31 of Year 0. The equipment would fall into the MACRS 5-year class, and it would cost $10 million, including transportation and installation. The annual depreciation rate for the five years of economic life of the project would be: Year 1 20% Year 2 32% Year 3 19% Year 4 12% Year 5 11% e. f. h. At the end of the project, the building is expected to have a market value of $10 million and the equipment is expected to have a market value of $2 million. The production department has estimated that variable manufacturing costs would be $4000 per unit, and that fixed overhead costs, excluding depreciation would be $20 million a year. They expect variable costs to rise by 3 percent per year, and fixed costs to rise by 2 percent per year. Depreciation expense would be determined in accordance with MACRS rates. RIC must have an amount of NOWC on hand equal to 10 percent of the upcoming year's sales. RIC's marginal tax rate is 25 percent, its cost of capital is 12 percent, and it assumes that all operating cash flows occur at the end of the year. Evaluate the project using the NPV rule and the IRR rule. Problem 1 - Evaluating a New Project Project- 5 Year Life Building Purchase ?? Equipment Purchase ?? Total Initial Investment $ Unit Sales Price per Unit Total Sales Variable Cost per Unit Total Variable Costs Total Fixed Costs Depreciation Rate (39 Year) Building Depreciation Depreciation Rate (5 Year) Equipment Depreciation Total Depreciation Costs Earnings Before Income Tax (EBIT) Year 0 ?? ?? ?? ?? ?? ?? ***** ?? ?? ?? ?? Year 1 ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? Year 2 ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? Year 3 ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? Year 4 ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? Year 5 Tax Rate Total Taxes Net Operating Profits (NOPAT) Add Back Depreciation Operating Cash Flow NOWC Percentage Required ?? Net Operating Working Capital ?? Increase in NOWC ?? Total Annual Project Cash Flow ?? Terminal Year Cash Flow Building Sale (MV) Less: Book Value of Building Profit on Sale Tax on Loss (25%) Net Salvage Value on Building Equipment Sale (MV) Less: Book Value of Equipment Profit on Sale Tax on Profit (25%) Net Salvage Value on Equipment Total Net Salvage Value Free Cash Flow ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? Required Rate of Return (WACC) ?? NPV ?? IRR