Aardvark Engineering is a relatively small company in Eastern Washington that produces

avionic parts and equipment for both the commercial airline industry and the military. The

company recently won several contracts in 2020 for production starting in 2021. As a

result, the company needs to expand its production and testing capabilities. As CFO of

Aardvark, you are responsible for conducting the analysis of the capital project needed to

allow the company to fulfill the contracts.

Detailed discussions with the sales and marketing personnel indicate that sales in the first

year would be $72 million and grow at 4% per year through the ten year life of the project.

Accounting has indicated that the sales, general and administrative costs would be fixed at

$7.5 million for the life of the project. Accounting also estimates working capital needs at

18% of revenue. Engineering and Manufacturing have indicated that the cost of goods will

be 61% of sales.

The equipment is estimated to cost $54 million with an additional $39 million for

installation. It has a ten year economic life and falls within the 7 year MACRS class for

depreciation purposes. Engineering estimates that it can be sold for $6 million at the end of

the project life.

The new production facilities will also require a new building at a cost of $30 million. The

building has a 39 year life and is required to use straight line depreciation. The market

value of the building at the end of the project is estimated to be $13 million.

Aardvark's marginal tax rate is 36% and their initial discount rate is 15% which is

approximately equal to the weighted average cost of capital. The project risk is similar to

the overall company risk.

Now that the contract is signed, determine whether this project will be profitable for the

company. The board of directors requires all project analyses to include the net present

value, internal rate of return and payback period and that is your assignment.

Your final report must include the NPV, IRR and Payback Period for the project as well as

your analysis of the project. Bear in mind that the project may or may not be acceptable on

the basis of your results. If it is not, suggest a few modifications that may make it

acceptable. Your written report should include a discussion of the project as well as how

the cash flows are determined and measures of project desirability are determined.