Capital Budgeting topic

As a senior analyst for Lawton Enterprise, you have been asked to evaluate a new computer hardware project with the following characteristics: - Acquiring a computer hardware for a cost of $2,500,000. - The computer hardware has an expected six-year life. - The initial investment in net working capital (in Year 0 ) is $500,000. The investment in working capital is to be completely recovered by the end of the project's life (in Year 6). - The computer hardware can be depreciated on a straight-line (prime cost) basis and there is no expected salvage value after six years. - The produced software is expected to generate sales of $1,250,000 in Year 1. They grow at a 25% annual rate for the next two years, and then grow at a 10% annual rate for remaining years. - Fixed operating expenses are $100,000 for Years 1-3 and $110,000 for Years 4-6. - Variable operating expenses are 20% of sales in Years 12 and 25% of sales in Years 3-6. - Lawton does not have any available space where the project can be located for six years and you anticipate to rent the required office space it would cost $65,000 per year for the life of the project. You expect that the project will need to hire three new software specialists at $50,000 (each specialist) per year (start in Year 1) for the full six years to work on the software. - The project will use a van currently owned by Lawton. Although the van is not currently being used by Lawton, it can be rented out for $20,000 per year for six years. The book value of the van is $20,000. The van is being depreciated straight-line (with six years remaining for depreciation) and is expected to be worthless after the sixth year. - Lawton's marginal tax rate is 35%, and the discount rate is 11.5%. Based on the information presented above, answer the following questions. 1. (12 marks) Calculate the incremental free cash flow during the project's life (starting from Year 0 to Year 6). Show workings. 2. (13 marks) Calculate the NPV, payback period and IRR of the project. Should the project be accepted? Show workings and explain your answer(s). Page 2 of 6 Students may present the workings using the table below. Please set out your work clearly and neatly. If you choose you can take advantage of the table below or you can continue your workings on the following page which has been intentionally left blank