A firm is thinking about launching a new brand of bicycle. The initial investment in equipment that is needed for production is $800,000. The investment in the net working capital will be $60,000 at the beginning of the project. The firm has decided to finance the project with a mixture of equity and debt. The interest expenses on the debt are going to be $30,000 per year. The project has an estimated life of five years. The revenue per year is estimated to be $450,000, and operating costs per year is estimated to be $300,000.

The tax rate is 30% and the CCA rate for depreciation purposes is 20%. The equipment will be sold at the end of the project for $80,000. The firm expects that it will be able to recover 90% of its investment in net working capital at the end of the projects life (i.e., final year of the project). The remaining 10% will never be recovered.

To judge the feasibility of the project, the firms management has travelled extensively in several cities in Canada. Those travel related expenses amount to $200,000. Fifty percent of those expenses have been paid already, 25% will be paid six months from now, and the remaining 25% will be paid at the end of year 1.

The company considers that the risk of the project is the same as the risk of its existing operations. Therefore, it has decided to use the firms cost of capital as the required rate of return (discount rate) for the project. Currently, the after-tax cost of debt of the firm is 4.2%, and its cost of equity is 10%. The capital structure of the firm, based on market values, indicates that assets are financed by 60% of equity and 40% of debt.

Calculate the NPV of the project to see if the company should undertake this project.

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