Amadeus Corporation is considering the issue of a new product to be added to its product mix. They hired you, a recent business graduate, for conducting the analysis. The production line would be set up in an unused space at the companys main plant. The plant space could be leased out to another firm for $25,000 per year. They have to buy new machinery. The approximate cost of the machine would be $200,000, with another $10,000 in shipping and handling charges. It would also cost an additional $30,000 to install the equipment. The machinery has an economic life of 5 years and would fall under Class 8 with a CCA rate of 20%. The machinery is expected to have a salvage value of $25,000 after 5 years of use. The company will retool one of its existing manufacturing facilities to produce the new model. The one-time retooling cost is $1700. There will also be $8,000 in retraining costs incurred for workers who lost their jobs manufacturing the existing product. The new product line would generate incremental sales of 1,250 units per year for 5 years and they are expected to grow 10% per year. The cost per unit is estimated in $75 per unit in the first year. Each unit can be sold for $200 in the first year. The sales price and cost are both expected to increase by 2.5% per year due to inflation. The fixed costs are estimated to be $100,000 per year and would increase with inflation. To handle the new product line, the firms net operating working capital would have to increase by an amount equal to 15% of sales revenues. The firm tax rate is 35%, and its overall weighted average cost of capital (WACC) is 14%.

The project is considered by the financial department to be as risky as the company.

1. Using an Excel spreadsheet:

Find the NPV, IRR and Payback of the project by using the pro forma financial statement method to determine cash flows.

Enter the input variables in cells of their own at the top of the spreadsheet (so it is easier to do sensitivity analysis calculations).

Set up the necessary equations by referencing to the input variable cells. The spreadsheet must be formula driven; do not put any numbers in equations, only cell references.

Use Excels built-in functions wherever possible (e.g. PV and IRR functions).

2. Assume that you are confident of your estimates of all variables that affect the projects cash flows except unit sales and sales price. If product acceptance is poor, unit sales will be only 900 units a year and the unit price will be only $160; a strong demand will produce sales of 1,600 units and a unit price of $240. The marketing department told you that there is a 25% chance of poor acceptance and 25% chance of excellent acceptance, and a 50% chance of average acceptance (the base case).

(a) What is the worst case NPV and the best case NPV? Material prepared by Prof. Eloisa Perez and edited by Vicky Nie

(b) What is the expected NPV for this project considering all possibilities?

Should the company go through with the project? yes or no