Gustav is considering expanding his business with a new fresh meat food product. Because Gustav leaves on a business trip, he asked you to evaluate the free cash flows generated by this project and perform several sensitivity analyses. He will make the final decision.

The product will be produced in a building owned by Gustav. The building is fully depreciated, and it is not currently in use. However, Gustav can rent the building to his brother Kasper for $$25,000$ per year starting next year.

The required equipment would cost $$200,000$ plus an additional $$30,000$ in shipping and $$10,000$ in installation. The machinery could be depreciated under the MACRS system as $3-$year property. In addition, inventories would rise by $$20,000,$ while accounts payable would increase by $$5,000$ and accounts receivables by $$5,000.$ The project is expected to operate for $4$ years when it will be terminated. At the end of the project's life, the equipment is expected to have a salvage value of $$25,000.$

Unit sales are expected to total $100,000$ units per year, and the expected sales price is $$2\mathrm{.}00$ per unit during the first year. The selling price will increase by $3\%$ annually with inflation. Cash operating costs for the project are expected to total $60\%$ of sales.

Gustav expects the new product to take sales away from his existing business. He estimates a loss of $$5,000$ per year.

The company's tax rate is $40\%.$

Gustav calculated the company's cost of capital for you. It is $5\%.$

Completion Instructions:

What if the cost of capital changes? Perform a sensitivity analysis with the cost of capital varying between $2\%$ and $7\%.($Use $1\%$ increments.$)$

What happens with the NPV as the cost of capital increases? How does your decision change? What happens with the IRR as the cost of capital increases? How does your decision change?