ECOSOL, Inc.

ECOSOL, Inc. is a successful technology, supply, and equipment company. ECOSOL provides technical, software and equipment solutions to a wide variety of companies. The firm has benefited from the swift growth in the globalization of supply chains and the world economy. although the Covid$-19$ pandemic and the Ukraine$-$Russia conflict has caused concern about the dependability of supply chains. Alex Walker, the corporate founder, is considering a push to manufacture its first product intended for the consumer market. The R&D arm of the company, led by Jenny Valdez, has recently developed a portable solar generator. This is not a new breakthrough product, as other companies are already producing solar generators. However, ECOSOL$$s new solar generator produces significantly more electricity more efficiently than any other portable solar generator currently on the market.

Should ECOSOL, Inc. proceed with this project, they will secure assembly operations within a facility they intend to lease for $$1\mathrm{.}5$ million per year. This lease is deductible for tax purposes, payable at the start of each year, and is subject to a $3\mathrm{.}0\%$ annual increment throughout the project$$s duration. Consequently, the initial lease at the beginning of Year $1$ will be $$1\mathrm{.}5$ million, with a subsequent annual rise of $3\mathrm{.}0\%.$ Equipment will cost of $$55$ million, covering both delivery and setup. Additionally, an upfront Net Working Capital of $$5\mathrm{.}0$ million is required to facilitate operations. This investment in Net Working Capital is planned to be recovered at the conclusion of the project after six years, by which time it will no longer be necessary.

Equipment depreciation will be according to MACRS $5$year asset class $(20\mathrm{.}00\%,32\mathrm{.}00\%,19\mathrm{.}20\%,11\mathrm{.}52\%,11\mathrm{.}52\%,$ and $5\mathrm{.}76\%$ respectively for years one through six$).$ $$10\mathrm{.}0$ million is the equipment is expected salvage value after $6$ years of use.

ECOSOL expects to produce and sell each solar generator at an initial price of $$1,500$ per unit. The facility$$s annual maximum production capacity is expected to be $100,000$ units during the $6-$year economic life of the facility. The forecast is for actual production and sales to be $70,000$ units annually. Fixed cash operating costs $($not including depreciation and lease payment$)$ are estimated to be $$22\mathrm{.}0$ million annually, and variable cash operating costs are estimated at $$900$ per unit. ECOSOL$$s federal$-$plus$-$state effective tax rate is $30\%.$ Assume that the company is able to take advantage of all tax shields $($tax$-$deductions$).$

ECOSOL$$s weighted average cost of capital $($WACC$),$ and thus the project$$s required rate of return, is $15\%.$

Bob Burton, the CFO, wondered whether it would be appropriate to assume neutral inflation equal to the $4\mathrm{.}0\%$ expected general rate of inflation, and if not, how sensitive the results would be to alternative assumptions of differential inflation impacts on revenues and costs.

In addition to the basic capital budgeting analysis, Bob would like you to perform a risk analysis on the new capital budgeting project. The project appears to be profitable, but what are the chances that it might nevertheless turn out to be a loser.

You met with Rowena Campbell of engineering and Bill Clark from marketing to get a feel for the uncertainties involved in the cash flow estimates. After several sessions, you concluded the greatest uncertainty involved unit sales, variable cash operating costs and salvage value. Unit sales and the variable cost of production could vary widely, and the realized salvage value could be quite different from the estimates.

As estimated by Bill$$s marketing staff, if product acceptance is "normal" $($base case$),$ then sales quantity during the life of the project would be $70,000$ units annually. If acceptance is $$poor$($worst case$),$ then only $50,000$ units would be sold annually during the life of the project; and if consumer response is $$strong$($best case$),$ then the sales volume would be $90,000$ annually during the life of the project.

As estimated by Rowena$$s engineering staff, the equipment$$s salvage value at the end of $6$ years could be as low as $$7\mathrm{.}5$ million and as high as $$16\mathrm{.}5$ million. If product acceptance is low $($worst case$),$ the equipment$$s salvage value will likely be about $$7\mathrm{.}5$ million. If product acceptance is high $($best case$),$ the equipment$$s salvage value will likely be about $$16\mathrm{.}5$ million. If product acceptance is normal, then salvage value is expected to be $$10\mathrm{.}0$ million.

Other worst case and best case assumptions include:

Best Case Worst Case

Unit Price $$1,700$ $$1,300$

Unit Variable Costs $$750$ $$1,050$

Price Inflation $7\mathrm{.}0\%1\mathrm{.}0\%$

Operating Costs Inflation $1\mathrm{.}0\%5\mathrm{.}0\%$

ECOSOL$$s Executive Committee requires that all sensitivity analyses consider changes in at least the following variables: unit sales, unit sales price, unit variable cash operating costs, fixed cash operating costs, and salvage value. The lease payment is fixed by contract so there is no reason to include the