John Crockett Furniture Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by Joan Samuel, a recently graduated finance MBA. The production line would be set up in unused space in Crocketts main plant. The machinerys invoice price would be approximately $200,000; another $10,000 in shipping charges would be required; and it would cost an additional $30,000 to install the equipment. Further, the firms inventories would have to be increased by $25,000 to handle the new line, but its accounts payable would rise by $5,000. The machinery has an economic life of 4 years, and Crockett has obtained a special tax ruling that places the equipment in the MACRS 3-year class. The machinery is expected to have a salvage value of $25,000 after 4 years of use. The new line would generate $125,000 in incremental net revenues (before taxes and excluding depreciation) in each of the next 4 years. The firms tax rate is 40%, and its overall weighted average cost of capital is 10%.

a.Construct the projects cash flows over its four-year life. Based on these cash flows, what are the projects NPV and IRR? Do these indicators suggest that the project should be undertaken?

b. Assume now that the project is a replacement project rather than a new, or expansion, project. Describe how the analysis would differ for a replacement project.

c. Explain what is meant by cash flow estimation bias. What are some steps that Crocketts management could take to eliminate the incentives for bias in the decision process?