Capital Budgeting Problem$$Chapter $6$ RWJJ

The Baldwin Company

The Baldwin Company is a producer of tennis balls, baseballs, footballs, and golf balls. It is now in search of new profitable investments and is investigating the marketing potential of brightly colored bowling balls. It has already spent $$250,000$ on questionnaires to consumers to see what their opinion about this new product would be$.$ The results were encouraging.

The Baldwin Company is now considering investing in a machine to produce bowling balls. These bowling balls would be manufactured in a building owned by the firm. This building, which is vacant, and the land it$$s sitting on could be otherwise sold for $$150,000$ after taxes.

The guy in charge summarized the details of the project as follows:

$-$ The cost of the bowling ball machine is $$100,000,$ and it is expected to last $5$ years.

$-$ The machine has an estimated market value at the end of $5$ years of $$30,000$ and will be depreciated according to a $5-$year MACRS schedule $($see your textbook for this schedule$).$

$-$ Production by year during the $5-$year life of the machine is expected to be: $5,000$ units $($Year $1),8,000$ units $($Year $2),12,000$ units $($Year $3),10,000$ units $($Year $4),$ and $6,000$ units $($Year $5).$

$-$ The price of bowling balls in the first year will be $$20$ and is expected to grow at $2\%$ per year.

$-$ First$-$year production costs are expected to be $$10$ per unit, and the cost of the material used to produce the bowling balls is expected to grow at $10\%$ per year.

$-$ Inflation is expected to be $5\%$ per year.

$-$ The corporate tax rate in the bowling ball project is $34\%.$

$-$ Management has determined that if the project is undertaken, an immediate $($Year $0)$ investment of $$10,000$ in net working capital is required $($e$.$g$.,$ for the inventory required$).$ Net working capital for the following years is projected to be $$10,000($Year $1)$; $$16,320($Year $2)$; $$24,970($Year $3)$; and $$21,220($Year $4).$ Working capital will be completely recovered by the end of the project$$s life.

Given this information, answer the following questions:

$1.$ What is the NPV of this project for Baldwin Company, assuming that the appropriate discount rate for this type of cash flows is $10\%?$

$2.$ Should Baldwin get involved in this project?

$3.$ Perform a sensitivity analysis of the project$$s NPV to the choice of discount rate $($i$.$e$.,$ draw the NPV profile$).$ How high does the discount rate need to be for the project to be rejected?