Question
ABC Auto Corporation is evaluating the feasibility of producing a newly invented hybrid car. The new model will enable drivers to use both gas and
ABC Auto Corporation is evaluating the feasibility of producing a newly invented hybrid car. The new model will enable drivers to use both gas and electricity to fuel the car. It also has a lot of new build-in functions superior to other similar cars in the market. The company has already spent $0.5 million over the past 2 years in developing and testing this new car model. To make sure the car will hit the market successfully, ABC recently hired a consulting firm to do a thorough marketing research. The firm charged ABC $30,000 for this service.
The new project will require an initial investment of $12 million in equipment. The project is expected to run for 3 years, and the equipment purchased for this project will then be sold at the market after 3 years of use. The equipment will be depreciated using straight-line method for 3 years. Its market salvage value after 3 years is estimated to be $450,000.
This project will create $700,000 sales and help the company to save $150,000 costs in each year. The discount rate that company uses is 12%, and its corporate income tax rate is at 40%.
As the CFO of ABC Auto Co., you are asked to conduct capital budgeting analysis, and then provide your recommendation to the board of directors in an executive summary.
- Identify which of the cash flow described in the case are incremental cash flow (i.e. relevant and needed in capital budgeting analysis). Provide your brief explanation for your answer.
- Calculate each year’s incremental cash flow: year 0 (initial time), year 1, year 2, and year 3. You MUST show your work to earn credit
- Use 3 methods (NPV, IRR, Payback) to separately evaluate the project. You MUST show your work.
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