Question
Based on the following case could you help me answer questions 2) and 3): The company has received a request to deliver a project for
Based on the following case could you help me answer questions 2) and 3):
The company has received a request to deliver a project for a customer. The project will provide an expected revenue of $1.9 million each year over the next four years. The variable cost each year is expected to be 35% of sales.
If the company accepts the new project, they will have to make a new investment of $2 million in equipment. The investment in equipment is to be depreciated over the life of the project on a straight-line basis and has a salvage value of 200,000 with a contract for sale in year four.
In addition, other fixed costs, excluding interest cost, are expected to increase by $350,000 each year.
To finance the investment, the company intends to take up a bank loan for $800,000 at the beginning of the period and will repay the loan in one lump sum in year four. The interest is expected to be 8% and will be paid at the end of each year.
The company expects to receive an advance payment of $300,000 from the customer for the project as a deposit. The deposit will be refunded in full to the customer once the project is fully complete.
Assume that the tax rate is 23%.
2. Given that the company has a relevant cost of capital of 15%, would you advise them to conduct this project? Explain your answer.
3. What is the internal rate of return and what does that tell you?
Thank you in advance.
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