ABC plc. is a leading producer of beach equipment. The company is currently

evaluating a new product: a self-folding beach umbrella. The new production

equipment will cost 400,000, while shipping, installation and insurance expenses

will total an additional 50,000; these expenses will be involved in the overall

equipment costs and will be depreciated alongside. Further, ABCs working capital

would have to be increased by 10,000 at the time of the initial investment; this

investment in working capital will be recovered when the project is terminated. The

machinery has an economic life of 4 years, and the company can make use of special

tax laws that allow them to apply the following annual depreciation rates on the total

cost of the machinery: 0.4, 0.3, 0.2 and 0.1 in Years 1 through 4, respectively. The

machinery will have been fully depreciated at the end of Year 4, but the management

anticipate that they will be able to sell it at Year 4 at a price of 80,000. The new

production will take place at a part of the ABCs main factory building that was

recently refurbished as part of a routine annual building refurbishment program; ABC

spent 100,000 to refurbish this specific part of the factory building.

ABCs management expects to sell 120,000 beach umbrellas annually during the

next 4 years, at a price of 10.00 per umbrella, of which 8.00 per umbrella cover

fixed and variable costs. While working on the sales figures, the sales department

notified the management that some customers that would otherwise buy the regular

beach umbrellas, will now turn to the new product, causing the regular umbrellas

sales figure to drop by 120,000 annually; however, this drop in the regular umbrellas

production will also lead to a fall in the respective costs by 40,000. ABCs cost of

capital is 10%, and the companys tax rate is 20%. Assume that ABC will be a

profitable company in the next 4 years.

QUESTIONS:

1. Calculate the expected non-operating terminal (Year 4) cash flow of the project.
2. Calculate the projects final annual net cash flows (including operating and nonoperating).
3. Suppose that the sales price will increase with an annual inflation of 5% beginning after Year 0, and that costs will increase by 2% per year. Calculate the projects new final annual net cash flows.
4. Evaluate the project for both sets of cash flows (as calculated in questions 2 and 3 above) according to its NPV, IRR, Profitability Index, and Payback Period
5. Assume that tax authorities had not allowed the special tax laws that allowed the company to apply the above-mentioned depreciation rates, and the company would have to use the straight-line depreciation method. Discuss and show how this would affect the NPV and the IRR of the investment project (assume no inflation - as in Q2 and that all other parameters remain stable).