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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

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.

1.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 Q6 and that all other parameters remain stable).

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