Question
Assume your company is considering the feasibility of introducing a new product line. They evaluate such projects by determining the net present value and internal
Assume your company is considering the feasibility of introducing a new product line. They evaluate such projects by determining the net present value and internal rate of return.
The company recently completed a feasibility study that indicated they would be able to sell as much of the new product as they can produce. The study was performed by Feasibility Consultants, Inc. at a cost of $100,000.
Your company has also determined facility needs that will accompany the expansion. Warehouse expansion will cost $500,000 and will be depreciated using the 5-year MACRS depreciation schedule. (.20, .32, .192, .1152, .1152, .0576). Equipment installation costs will total $50,000. The company currently owns land next to their existing facility that can be used for the expansion. The land was purchased 10 years ago for $5,000. Current market value for the land is $20,000.
In order to finance the expansion, the company plans to issue $500,000 in bonds. The bonds will have a 10% coupon rate and will mature in 10 years. They will have to pay $50,000 per year in interest on the bonds.
Based on the risk profile of this project, your company will use a hurdle rate of 10.1% when evaluating this project. Assume for this exercise that your companys marginal tax rate is 35%.
Your company has determined that the expansion will allow them to sell 1,000,000 pounds of product per year at an estimated price of $0.30 per pound. Fixed costs per year are forecast at $40,000. Variable costs of $0.10 per pound are forecast.
Your company forecasts the following one-time changes in working capital in year 0:
Inventory will increase $20,000
Accounts receivable will increase $10,000
Accounts payable will increase $8,000
Any increase in NWC should be recaptured at the end of year 7.
Due to anticipated technological changes in the industry, your company is forecasting zero cash flow from this project beyond year 7.
Your companys financial analysts forecast that the equipment that was purchased for this project can be sold for $40,000 at the end of year 7.
Help your companys CFO evaluate the project by completing the following in Excel:
Find annual cash flows for years 0 through 7.
Find the net present value.
Find the internal rate of return.
Should they do the project? Why or why not?
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