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KU Flower is considering the construction of a new facility to update its flower production. The farm has the following information about the proposed new
- KU Flower is considering the construction of a new facility to update its flower production. The farm has the following information about the proposed new facility project. The project has an anticipated economic life of 10 years.
- The new facility will be constructed on a piece of land that the farm currently owns. The land has a current market value of 5 million. If KU flowers LTD does not use the land for this project, the land will instead be sold.
- Last year the farm spends 500,000 to grade the land and to put in water lines. The company has capitalized these costs and is recording them on their income statement at 100,000 per year over the next 5 years.
- Construction of new production facility will require an immediate outlay (at t =0) of 15 million.
- The production facility will be depreciated on a straight-line basis over 10 years to a 5 million salvage value. KU flowers LTD plans to sell the production facility to a competitor at the end of the 10-year period for 5 million.
- If the company accepts the project, the land will be sold with the production facility in 10years for its current book value, which is 2 million.
- If the company goes ahead with the proposed project, it will require an immediate increase in inventory of 1,800,000, but will also result in an immediate increase of 800,000 in accounts payable. Each of these positions will be reversed at the completion of the project.
- The new facility is expected to reduce annual operating expenses, excluding management salaries by 8 million per year for each of the next 10 years. No change in annual revenue is expected.
- The accounting department plans to allocate the annual salaries of 5 managers to this new facility, however, only 2 new managers will actually be hired by the company. Each of these managers will earn 200,000 per year for the next 10 years.
- The companys interest expense each year will be 300,000
- The companys cost of capital (i.e, the required rate of return on this project) is 12%.
- The companys tax rate is 40%
Calculate:
- The initial investment for the project
- The fourth year expected incremental operating cash flow
- The 10th year incremental non-operating cash flow
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