Question
A successful computer business company is considering a new product line that require a new machine. It will cost $36,000,000. It will be fully depreciated
A successful computer business company is considering a new product line that require a new machine. It will cost $36,000,000. It will be fully depreciated to a zero book value on a straight line basis over 4 years. The project will generate $100,000,000 in sales each year for 4 years. Variable costs are 75% of sales and fixed costs are $8,500,000 per year for 4 years. To get the project started and for each year, net operating working capital (NOWC) is 1% of the next year's sales. The company will have $5,000,000 annually in interest expense as part of the financing. Tax rate is 25%. The company's financial advisor estimates the cost of capital (required return) as 14%. Note: Variable and fixed costs do not include depreciation or interest expense. a) Calculate the net present value (NPV) and internal rate of return (IRR). b) Should they consider the new line? Why? c) The financial manager is concerned about their estimates and conducts a scenario analysis. Variable costs could be 70%, 75% (expected) or 80% of sales and the cost capital could be 10%, 14%(expected) or 16%. Use a data table to analyze the NPV. What can you conclude and why is this important for evaluating the project?
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