Capital Budgeting Analysis Problem:

Please show all work clearly.

The proposal involves investment in group of machines that would greatly increase the firm's ability to manufacture large quantities of remote controls. The purchase price of this machinery would be $1.17 million and installation costs would total $50,000. The remote control equipment would have a useful life of 7 years, and for tax purposes, depreciation charges would be according to the 7-year MACRS class that applies for most industrial equipment (the amount to be depreciated is the sum of the machinery and installation costs).

It is anticipated that the variable operating costs, excluding depreciation, will be approximately 59 percent of sales. In the project's first year, fixed costs (maintenance, etc.) are projected to be $30,000. In each of the remaining years, this fixed cost component is projected to increase by 1.5% over the preceding year. The firm's accountant has suggested that a portion of the firm's overall interest charges should be allocated to this project and he is recommending a figure of $39,000 per year, for each year of the project's estimated useful life. The accountant also noted that the portion of the factory that would house this new remote control machinery underwent a major 'renovation' last year with a total cost of $115,000. Because the remote control project would not have been feasible without the renovation, The accountant suggests that the costs of the renovation should be considered as one of the remote control project's initial expenses.

In addition to the initial outlay for the remote control machinery, the firm anticipates that it will have to make incremental working capital investments to parallel the expected changes in sales. Analysis has resulted in the estimate that a proper working capital requirement figure would be 8.25 percent of incremental sales (i.e., the NWC investment (or recovery) at time t will be 8.25% of the in sales between time t, and t + 1). Management expects the machinery to be sold for a before-tax scrap value of $57,000 at the end of year 7. The revenue flows anticipated for this investment are shown below.

Year 1: $270,000

Year 2: $500,000

Year 3: $750,000

Year 4: $1,100,000

Year 5: $1,100,000

Year 6: $1,000,000

Year 7: $725,000

The CFO requests your assistance in preparing an analysis of the net cash flow projections for the proposed investment in the new line of remote control machinery. In particular, he is interested in the Net present value and IRR. You have also been provided with the following information:

The firm has 1,750,000 shares of common stock outstanding that are trading for $25.65 per share.

Rf = 3.1% (risk-free rate)

= 0.98

Market risk premium = 7%

Average tax rate = 20%

Marginal tax rate = 24%

The firm's bonds have 6.9% coupon rate, a $1,000 face value, pay semi-annual coupons, and mature in 6 years. There are 10,000 of these bonds outstanding that are currently selling in the open market for $997.07

The CFO has requested that you create the cash flows for this project and using the WACC as the discount rate, report the project's NPV, IRR, and provide your recommendation regarding whether it should be accepted or rejected. The details of your cost of capital calculations and cash flow projections should be clearly presented. Use the following official IRS depreciation schedule in your analysis

7 Year MACRS Schedule of Depreciation:

Year 1: 14.29%

Year 2: 24.49%

Year 3: 17.49%

Year 4: 12.49%

Year 5: 8.93%

Year 6: 8.92%

Year 7: 8.93%

Year 8: 4.46%