Fanning Analytics manufactures a variety of electronic products. The company is considering introducing its most exciting product; a new digital instrument panel for customized classic cars. This panel allows the car owner to customize the complete set of instruments for the vehicle. Output display may be analog or digital, with many styles of display using apps that may be purchased, downloaded, and installed with a micro SD card. Your analysts have provided you with the following forecast information for the Fully Customizable Instrument Panel (FCIP):

The project has an anticipated economic life of 3 years.

The company will have to purchase a new machine to produce the detergent. The machine has an up-front cost (t = 0) of $2,468,000.

The equipment will be depreciated using the MACRS method using the year convention with a 3 year class life:

t = 1 33.33%

t = 2 44.45

t = 3 14.81

t = 4 7.41

At the end of the project, the expected value (salvage value) of the equipment is $225,500.

If the company goes ahead with the proposed product, it will have an effect on the companys net operating working capital. At the outset, t = 0, inventory will increase by $275,000 and accounts payable will increase by $23,925. At t = 3, the net operating working capital will be recovered after the project is completed.

The detergent is expected to generate incremental sales revenue as follows:

Year 1: $3.275 million

Year 2: 3.750 million

Year 3: 2.950 million

(After the third year, the project will no longer provide any additional incremental sales.)

The operating costs, excluding depreciation, are expected to be 62% of the annual sales.

The new detergent is expected to reduce the after-tax cash flows of the companys other existing products by $158,000 a year (t = 1, 2, and 3).

The companys tax rate is 40 percent.

Fanning considers this to be a higher risk project.

The before tax cost of debt (r_d) for Fanning is 6.10%, and the common stock beta is 1.15. The current capital structure (market value) is as follows:

Fanning, Ind.

Debt $166,667

Equity 833,333

$1,000,000

Fanning uses the firms WACC for average risk projects, it adds 2% for high risk projects. For low risk projects it uses the WACC less 2%.

Your analysts also compiled current market information:

Market risk premium (RP_m): 4.00%

Risk-free rate (r_RF): 2.50%

3. (Show your calculations)

(10 points) Using the following cash flows and a hurdle rate of 9%, what is the NPV of the project?

Period Cash flow

I. Initial 0 (2,545,000)

II. Operating 1 950,400

2 955,100

3 863,300

III. Terminal 3 283,500

b. (6 points) Using the cash flows in 3.a. above, what is the internal rate of return (IRR) for the project?

c. (3 points) (Choose the correct response and fill in the blank.)

If the NPV is positive, the IRR will be _______________ [greater than / less than] the hurdle rate.

The Modified IRR will be _____________ [greater than/ less than] the hurdle rate.

The Modified IRR will be _________________ [greater than/ equal to / less than] the regular IRR.

d. (5 points) Should the project be accepted? Why?