ABC is an American cooky and cake manufacturer and the largest retail supplier of cookies globally. ABC is known for its great quality but has not tailored its products to the entire spectrum of the market. In particular, so far it has not produced gluten-free cookies or cakes but is considering to manufacture these as well. ABC has most of the equipment to produce gluten-free products, however, it needs to install a couple of new mixers which requires an investment of $2,800,000.

ABC has hired a firm of consultants to assess whether entering the gluten-free niche market is interesting and to provide estimates of the impact of the purchase of these mixers on the revenues and costs of the firm. The consultants expect that upon entering the gluten-free market, revenues will increase with $640,000 a year for the upcoming years, while the operating costs will increase with $40,000 because specialized employees need to operate the new machines. ABC received a bill for this advice totalling $24,000 that has to be paid in separate instalments of $4,000 yearly over the next 6 years.

The new mixers will be depreciated on a straight-line basis over their life of 6 years and will then be sold. Management expects that the fiscal residual (salvage) value of the mixers will be $1,000,000 after 6 years, whereas the re-sale (market) price of the machine is estimated at $600,000 after 6 years. ABC faces a corporate tax rate of 40%. You can assume the Modigliani-Miller theorem holds, so there are no frictions or market imperfections, except for the corporate tax.

1. Calculating the Internal Rate of Return is a method to evaluate projects that has several drawbacks as such it is generally not the preferred method to evaluate projects. Would it be appropriate to apply the IRR-method for this project? Explain why or why not?

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