Axylotl Industries, Inc. is a relatively small company in Eastern Washington that produces avionic parts and equipment for both the commercial airline industry and the military. The company recently won several contracts in 2020 for production starting in 2021. As a result, they need to expand their production and testing capabilities. As CFO of Axylotl Industries, you are responsible for conducting the analysis of the capital project needed to allow the company to fulfill the contracts.

Detailed discussions with the sales and marketing personnel indicate that sales in the first year would be $61 million and grow at 3.5% per year through the ten year life of the project. Accounting has indicated that the sales, general and administrative costs would be fixed at $8 million for the life of the project. Accounting also estimates working capital needs at 22% of revenue. Engineering and Manufacturing have indicated that the cost of goods will be 62% of sales.

The equipment is estimated to cost $55 million with an additional $40 million for installation. It has a ten year economic life and falls within the 7 year MACRS class for depreciation purposes. Axyolotl Industries estimates that the equipment can be sold for $3 million at the end of the project life.

The new production facilities will also require a new building at a cost of $19 million. The building has a 39 year life and is required to use straight line depreciation. The market value of the building at the end of the project is estimated to be $9 million.

Axylotl Industries' marginal tax rate is 35% and the project will initially use 14% as the cost of capital although this is not the company's present weighted cost of capital. The WACC will be refined using the book value weighted average cost of capital you will calculate in Part B.

Now that the contract is signed, determine whether this project will be profitable for the company. The board of directors requires all project analyses to include the net present value, internal rate of return, payback and profitability index.

Your written report for Part A should include a discussion of the project in general as well as how the cash flows are determined and measures of project desirability are determined. The report should be relatively brief but include the calculation of Net Present Value (NPV), Internal Rate of Return (IRR) and the Payback Period.

Market Risk Premium

0.09.

T-Bill Rate

0.03

T-Bond Rate

0.039

Tax Rate

0.35

Beta

1.25

Current Long-Term Debt Yield

0.058

Preliminary Discount Rate

0.14

Axylotl Industries, Inc.

Balance Sheet as of December 31, 2020

Thousands of $

Assets

Current Assets:

Cash

37,000

Accounts Receivable

96,000

Inventory

131,200

Total Current Assets

264,200

Long-Term Assets:

Plant, Property and Equipment

186,000

Other Assets

21,700

Total Long-Term Assets

207,700

Total Assets

471.900

Liabilities and Equity

Current Liabilities:

Accounts Payable

63,000

Commercial Paper

0

Accrued Expenses and Taxes

17,000

Long Term Debt Maturing within 1 Year

Capital Lease Obligations Due within 1 Year

Total Current Liabilities

80,000

Long Term

Liabilities:

Long-Term Debt

167,500

Capital Lease Obligations

Deferred Income Taxes

Total Long-Term Liabilities

167,500

Total Liabilities

247,500

Shareholder Equity:

Common Stock

18,000

Capital in Excess of Par

18,000

Retained Earnings

188,400

Total Equity

224,400

Total Liabilities and Equity

457.200