Question
Juicy Candy Company is considering expanding by buying a new (additional) machine that costs $115,000, has zero terminal disposal value, and has an 8-year useful
Juicy Candy Company is considering expanding by buying a new (additional) machine that costs $115,000, has zero terminal disposal value, and has an 8-year useful life. The company expects the annual increase in cash revenues from the expansion to be $61,000 per year. It expects additional annual cash costs to be $40,000 per year. Its cost of capital is 6%. Ignore taxes
REQUIRED
1. | Calculate the net present value and internal rate of return for this investment. |
2. | Assume the finance manager of Juicy Candy Company is not sure about the cash revenues and costs. The revenues could be anywhere from 6% higher to 6% lower than predicted. Assume cash costs are still $40,000 per year. What are NPV and IRR at the high and low points for revenue? |
3. | The finance manager thinks that costs will vary with revenues, and if the revenues are 6% higher, the costs will be 7% higher. If the revenues are 6% lower, the costs will be 6% lower. Recalculate the NPV and IRR at the high and low revenue points with this new cost information. |
4. | The finance manager has decided that the company should earn 2% more than the cost of capital on any project. Recalculate the original NPV in requirement 1 using the new discount rate and evaluate the investment opportunity. |
5. | Discuss how the changes in assumptions have affected the decision to expand. |
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