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As the financial advisor to All Star Manufacturing you are evaluating the following new investment in a manufacturing project: - The project has a useful

As the financial advisor to All Star Manufacturing you are evaluating the following new investment in a manufacturing project: -

  • The project has a useful life of 8 years.
  • Land costs $12m and is estimated to have a resale value of $25m at the completion of the project.
  • Buildings cost $12m, with allowable depreciation of 8% pa reducing balance and a salvage value of $10m.
  • Equipment costs $5m, with allowable depreciation of 15% pa reducing balance and a salvage value of $1m. An investment allowance of 20% of the equipment cost is available.
  • Revenues are expected to be $14m in year one and rise at 5% pa due to growth.
  • Cash variable costs are estimated at 35% of revenue.
  • Cash fixed costs are estimated at $3.5m pa.
  • The firm has spent $2m on research and development for the project.
  • Managerial salaries of $900,000 will be allocated to the project, but these managerial positions will be unaffected by the acceptance of the project.
  • An amount of $200,000 has been spent on a feasibility study for the new project.
  • The project is to be partially financed with a loan of $14m to be repaid annually with equal instalments at a rate of 3% pa over 8 years.
  • Except for initial outlays, assume cash flows occur at the end of each year.
  • The tax rate is 30% and is payable in the year in which profit is earned.
  • The after-tax required return for the project is 12% pa.

Required

  1. Calculate the NPV. Is the project acceptable? Why or why not? Explain and defend your processes, answer, and calculations clearly.
  2. Conduct a sensitivity analysis showing how sensitive the project NPV is to:
    1. revenue growth of 0% and 10%
    2. fixed cost p.a. increase by $1m and decrease by $1m
    3. the required rate of return increase by 2% and decrease by 2%.

Run all above sensitivities separately on a stand-alone basis.

Explain and defend your processes, answer, and calculations clearly.

Show the NPV change compared to the original calculations.

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