BQC Capital Budgeting Mini-Case

Expansion Project Analysis

BQC's marketing department estimates sales of 20,000 units annually if units sell for a price of $2000 each, therefore annual sales are estimated at $40 million.

Additional manufacturing capacity is needed which BQC can acquire by purchasing an existing building at a cost of $12 million. The building will be bought and paid for on December 31, 2020. The necessary equipment needed for manufacturing will be installed in late 2020 and paid for at the same time as the building. Including transportation and installation, the cost of the equipment is $8 million. An additional $6 million investment in net working capital is needed and will be made on December 31, 2020.

The project has an estimated economic life of 4 years. At the end of this time, the building is expected to have a market value of $7.5 million and a book value of $10.908

million. The equipment would have a market value of $2 million and a book value of

$1.36 million.

The production department has estimated that variable manufacturing costs would total 60% of sales and that fixed overhead costs (excluding depreciation) would be $5 million a year.

In accordance with the Modified Accelerated Cost Recovery System (MACRS), depreciation expenses on the building would be $156,000 in 2021 and $312,000 in each of the years 2022, 2023, and 2024. For the equipment, depreciation expense is

$1,600,000 in 2021, $2,560,000 in 2022, $1,520,000 in 2023, and $960,000 in 2024.

BQC's marginal federal-plus-state tax rate is 40%; its cost of capital is 12%. For capital

budgeting purposes, the company's policy is to assume that operating cash flows occur at

the end of the year. Because the plant would begin operations on January 1, 2021, the first operating cash flows would occur on December 31, 2021. BQC believes this project has the same amount of risk as an average project. Calculate the NPV. Should BQC move forward with the expansion?