I1

SIG Ltd. is evaluating several projects. One of these is a four-year project that is expected to produce revenues of $4 million for the coming year, increasing by $4 million per year for the subsequent three years. Variable costs are expected to be 60% of revenue and annual fixed cost (excluding depreciation) is expected to be $1 million. Net working capital for the project at the beginning of every year is expected to be 20% of the revenue for that year. This project will require a capital expenditure of $5 million at the start of the project, depreciated straight-line to $1 million by the end of the project, at which point in time SIG Ltd. will be able sell the project assets for $3 million. The cost of capital for this project is 5% and the marginal corporate tax rate is 20%.

(a) Calculate the annual operating cash flows for the project. (9 marks)

(b) Calculate the annual net capital spending cash flows for the project. (3 marks)

(c) Calculate the annual changes in net working capital for the project. (3 marks)

(d) Use the NPV decision rule to determine whether SIG Ltd. should accept the project. (5 marks)

(e) Suppose SIG Ltd. has also used the IRR decision rule but has reached a conclusion that contradicts that in part (d). Assess two (2) plausible reasons for this occurrence. (5 marks)

(f) Suppose SIG Ltd. has awarded a contract three months ago to a vendor that will charge $0.5 million per year for each of the next four years for services that it will render to the company. Discuss how this will affect the project's NPV and your decision on the project. No calculations are required. (4 marks)