Due to a significant increase in the demand for its transformers Vesta Company is considering investing in a new business line.

The new business line is expected to produce 7,000 transformers per year, however due to fluctuations in demand the quantity could change in a range of - 20% to +20%.

Vesta estimates that net working capital of $50,000 will be needed to support the new business line and the existing excess capacity is enough to absorb fluctuation in demand.

The new line would require additional overhead expenses of $500,000 per year. Raw materials costs associated with the new line are expected to be 35% of the selling price. However, the purchasing manager advised that the quality and the price of the raw materials are not constant, therefore the cost could oscillate between 30% and 40% of selling price. The labor cost is expected to be 30% of the selling price.

The controller estimates that new machinery costing $7,500,000 would need to be purchased. This machinery has a 9 year useful life and an estimated salvage (terminal) value of $500,000. For tax purposes, assume that Vesta Company could use the straight-line method (with estimated salvage value considered in the calculation) or a CCA rate of 20% (class 8).

The selling price is estimated at $1,300 per transformer.

Further, assume that the weighted-average cost of capital (WACC) for Vesta is 12% (after-tax) and that the combined income tax rate is 40%. Finally, in year 4 the new machinery requires a software upgrade estimated to $30,000.

Required:

1. Calculate the NPV for 3 scenarios: base, worst, and best using the CCA rate of 20%.

2. Calculate the NPV sensitivity to changes in the units sold, using the straight-line method for tax purposes. Assume the base case for raw materials.