L01, 2 MA25-41. Post-Audit and Reevaluation of Investment Proposal: NPV Anthony Company's capital budgeting committee is evaluating a capital expenditure proposal for the production of a high-definition television receiver to be sold as an add-on feature for personal computers. The proposal calls for an independent contractor to construct the necessary facilities by December 31 of the current year at a total cost of $350,000. Payment for all construction costs will be made on that date. An additional $75.000 in cash will also be made available on December 31 of the current year, for working capital to support sales and production activities. Management anticipates that the receiver has a limited market life; there is a high probability that within six years all new PCs will have built-in high-definition receivers. Accordingly, the proposal specifies that production will cease after six years. The investment in working capital will be recov- ered on that date, and the production facilities will be sold for $80,000. Predicted net cash inflows from operations for the next six years are as follows: 20X1 $125,000 125,000 20X2 125,000 20X3 60,000 20X4 60,000 20X5 60,000 20X6..... Anthony Company has a time value of money of 14%. For capital budgeting purposes, all cash flows are assumed to occur at the end of each year. Required a. Evaluate the capital expenditure proposal using the net present value method. Should Anthony accept the proposal? b. Assume that the capital expenditure proposal is accepted, but construction delays caused by labor problems and difficulties in obtaining the necessary construction permits delay the completion of the project. Payments totaling $250,000 were made to the construction company on December 31 of the current year. However, completion is now scheduled for December 31, 20X1, and an addi- tional $150,000 will be required to complete construction. If the project is continued, the additional $150,000 will be paid at the end of 20X1, and the plant will begin operations on January 1, 20X2. Because of the cost overruns, the capital budgeting committee requests a reevaluation of the project, before agreeing to any additional expenditures. After much effort, the following revised predictions of net operating cash inflows are developed: 20X2. 20X3 20X4 20X5 20X6 $150,000 125,000 60,000 60,000 60.000 The working capital investment and disinvestment and the plant salvage values have not changed, except that the cash for working capital would now be made available on December 31, 20X1. Use the net present value method to reevaluate the initial decision to accept the proposal. Given the information currently available about the project, should it have been accepted? (Hint: Determine the net present value as of December 31 of the current year assuming management has not com- mitted Anthony to the proposal.) c. Given the situation that exists in early 20X1, should management continue or cancel the project? Assume that the facilities have a current salvage value of $95,000. (Hint: Assume that the decision is being made on January 1, 20X1.)
