Kemmerer Pen, a manufacturer of stationary, is considering a new investment that requires the use of an existing warehouse, which the firm acquired four years ago for $2 million but is currently redundant (unused). The warehouses market rental price is $200,000 (pre-tax) per year at year zero. Rental price for the warehouse will increase at a growth rate of 5% from year 1 to year 5. In addition to using the warehouse, the project requires an up-front investment into machines and other equipment of $6 million. This investment can be fully depreciated straight-line over the next six years for tax purposes with a salvage value of 0. However, the company expects to terminate the project at the end of five years and to sell the machines and equipment for $1.5 million. The project requires an initial investment (incur at Year 0) into net working capital equal to 5% of predicted first-year sales. Subsequently, net working capital is 5% of the predicted sales over the following year but will be fully recovered at the end of year 5. Sales of pens are expected to be $5 million in the first year and to stay stable for five years. Total manufacturing costs and operating expenses (excluding depreciation) are 60% of sales. And profits are taxed at 30%.

a) What are the free cash flows of the project from Year 0 to Year 5 respectively? (6 marks). If the cost of capital is 10%, what is the NPV of the project?

b) If a borrowing interest payment of $600,000 for this project is made per year during the investing period, will it change Kemmerer Pens investment decision?