Question
Jean Smith, the financial advisor to Creative Manufacturing is evaluating the following new investment in a manufacturing project:- The project has a useful life of
Jean Smith, the financial advisor to Creative Manufacturing is evaluating the following new investment in a manufacturing project:-
The project has a useful life of 8 years.
Land costs $10m and is estimated to have a resale value of $13m at the completion of the project.
Buildings cost $5m, with allowable depreciation of 10% pa reducing balance and a salvage value of $1m.
Equipment costs $4m, with allowable depreciation of 30% pa reducing balance and a salvage value of $1.5m. An investment allowance of 20% of the equipment cost is available.
Revenues are expected to be $8m for the first 4 years and $9m for the next 4 years.
Cash expenses are estimated at $4m in year one and rise at 4% pa.
The new product will be charged $400,000 of allocated head office administration costs each year even though head office will not actually incur any extra costs to manage the project.
An amount of $100,000 has been spent on a feasibility study for the new project.
The project is to be partially financed with a loan of $10m to be repaid annually with equal instalments at a rate of 5% pa over 8 years.
Except for initial outlays, assume cash flows occur at the end of each year.
The tax rate is 30% and is payable in the year in which profit is earned.
The after tax required return for the project is 12% pa.
Required
(a)Calculate the NPV.Is the project acceptable? Why or why not?
Conduct a sensitivity analysis showing how sensitive the project is to revenues, the resale value of the land and to the required rate of return. Explain your results.
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