Question
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.
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.Aardvarks 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
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