As a financial analyst, you must evaluate a proposed project to produce printer cartridges. The equipment would cost $55,000, plus $10,000 for installation. Annual sales would be 4,000 units at a price of $50 per cartridge, and the project's life would be 3 years. Current assets would increase by $5,000 and payables by $3,000. At the end of 3 years, the equipment could be sold for $10,000. Depreciation would be based on the MACRS 3-year class; so the applicable rates would be 33%, 45%, 15%, and 7%. Variable costs would be 70% of sales revenues, fixed costs excluding depreciation would be $30,000 per year, the marginal tax rate is 40%, and the corporate WACC is 11%. 1. What is the required investment, that is, the Year 0 project cash flow? 2. What are the project's annual net cash flows? 3. What is the terminal year project cash flow? You did a scenario analysis to better understand the project's NPV: Probability Unit Sales VC% NPV Best case 25% 4,800 60% 39,434 Base case 50% 4,000 70% 4,245 Worst case 25% 3,200 75% -25,080 The firm's project CVs generally range from 1.0 to 1.5. A 3% risk premium is added to the WACC if the initial CV exceeds 1.5, and the WACC is reduced by 0.5% if the CV is 0.75 or less. Then a revised NPV is calculated. What WACC should be used for this project? Permalink Reply As a financial analyst, you must evaluate a proposed project to produce printer cartridges. The equipment would cost $55,000, plus $10,000 for installation. Annual sales would be 4,000 units at a price of $50 per cartridge, and the project's life would be 3 years. Current assets would increase by $5,000 and payables by $3,000. At the end of 3 years, the equipment could be sold for $10,000. Depreciation would be based on the MACRS 3-year class; so the applicable rates would be 33%, 45%, 15%, and 7%. Variable costs would be 70% of sales revenues, fixed costs excluding depreciation would be $30,000 per year, the marginal tax rate is 40%, and the corporate WACC is 11%. 1. What is the required investment, that is, the Year 0 project cash flow? 2. What are the project's annual net cash flows? 3. What is the terminal year project cash flow? You did a scenario analysis to better understand the project's NPV: Probability Unit Sales VC% NPV Best case 25% 4,800 60% 39,434 Base case 50% 4,000 70% 4,245 Worst case 25% 3,200 75% -25,080 The firm's project CVs generally range from 1.0 to 1.5. A 3% risk premium is added to the WACC if the initial CV exceeds 1.5, and the WACC is reduced by 0.5% if the CV is 0.75 or less. Then a revised NPV is calculated. What WACC should be used for this project? Permalink Reply
