Firm XYZ is planning on opening a new factory. The initial cost to build the factory is $3.5 billion, the factory will last 7 years and will have a salvage value of $1.5 billion. It plans to use straight line depreciation and depreciate the factory toward a book value of $0.8 billion. Sales from the factory are expected to be $5 billion each year for the next 7 years and costs (other than depreciation) are 40% of revenues. Sunk costs are 30% of revenues. If Firm XYZ doesnt open the factory, it could extend Firm XYZ the current business and make $500 million every year. Additional capital expenditure is $300 million will be required at the end of each of the next 7 years. Inventories and A/P will immediately rise by $900 million and $400 million respectively and remain at these levels until returning to back to original levels at the end of the project (t=7). A/R will rise by $600 million after the first year (i.e., t=1) and remain at that level until falling back from to original level at the end of the projects life (i.e., t=7).

Assume the firms marginal tax rate is 40% and WACC is 7.17% Does the firm want to open this factory? What is IRR of this project?

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