Finance 211 Case 2-Capital Budgeting Analysis Pavarotti-in-You (PIY), Inc., projects unit sales for a new opera tenor emulation implant as follows: Year Unit Sales 1 90,000 2 100,000 3 110,000 4 117,000 5 65,000 Production of the implants will require $10 million in net working capital to start and additional net working capital investments each year equal to 35 percent of the projected sales increase (in $'s) for the following year. (Because sales are expected to fall in the fifth year of sales, there is no NWC for that year). Total fixed costs are $175,000 per year, variable production costs are $227 per unit, and the units are priced at $360 each. The equipment needed to begin production is $13.2 million. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus falls into class 8 for tax purposes (20 percent). As well, 6 million of the equipment cost is eligible for a 5% Investment Tax Credit. Assume at the end of year 5 this equipment can be sold for its scrap value of $1 million. To promote the Arts, the government is offering a non-taxable cash grant of 500,000 payable a year after the project has been started. PIY is in the 40 percent marginal tax bracket and has a required return on all its projects of 25 percent. 1. Based on these preliminary project estimates, what is the NPV of the project? 2. Calculate the projects IRR. 3. Based on this analysis what would be your recommendation to PIY? Mark Allocations Component Mark Initial Investment & Grant 2 Investment Tax Credit 2 Cash flows from Sales 11 Tax Shield 4 Net Working Capital 6 NPV 3 IRR 2 Recommendation 2 Presentation 4 Total 36