Question
Mercer Inc. is considering a proposal to manufacture high-end protein bars used as food supplements by body builders. The project requires use of an existing
Mercer Inc. is considering a proposal to manufacture high-end protein bars used as food supplements by body builders. The project requires use of an existing warehouse, which the firm acquired three years ago for $1.2 million and which it currently rents out for $140,000 (before tax). Rental rates are not expected to change going forward. In addition to using the warehouse, the project requires an up-front investment into machines and other equipment with the purchase price of $1.5m and shipping and handling fees of $180,000. This investment can be fully depreciated straight-line over the next 10 years for tax purposes. However, Mercer Inc. expects to terminate the project at the end of eight years and to sell the machines and equipment for $700,000. Finally, the project requires an immediately investment into net working capital equal to 15% of predicted first-year sales. Subsequently, net working capital each year is 15% of the predicted sales of the following year. Sales of protein bars are expected to be $2.2 million in the first year and increases by 5% per year until year 8 and no sales after that. Total manufacturing costs and operating expenses (excluding depreciation) are 60% of sales of the same year, corporate tax rate is 40%. The company borrows $700,000 from a bank to finance the project. Annual interest is $60,000.
The opportunity cost of capital is 10%.
Calculate NPV of the project. Should the project be accepted?
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