MS Inc is preparing the feasibility of a new line of product to diversify its existing portfolio. The initial survey was conducted to examine the potential demand for the product. The survey required an investment of $100,000 that was paid in advance. The survey was aimed at examining the market potential of the new product. It suggested that product can last for 8 years without warranting any incremental innovation or up gradation. The product is likely to attain maximum sales in year 4 and will gradually decline thereafter. Based on exploratory conversations with buyers, the projected unit sales were as follows.

The product will be priced at $120 per unit to start. However, with growing competition, MS expected the price to drop to $110 per unit after three years. The anticipated upfront working capital requirement is $20,000, while equipment, plant and machinery will cost $800,000. MS estimates that equipment will be worth 20% of cost at the end of its economic life. The Tax authorities accept equipment for depreciation under 8 years SL, while working capital investment is not eligible for depreciation shield. The net working capital is anticipated to remain at 15% of the sales for first three years and decline to 10% for the following periods. It is anticipated that 60% of the working capital will be recovered at the end. Due to excellent inventory management, MS invests in working capital in the year of sales. The variable cost is likely to remain at $60 per unit throughout the product life while fixed costs (excluding depreciation are estimated at $25000 per year. The marginal tax rate for MS Inc is 35%. The firm is likely to maintain its historical debt to total assets ratio of 40% with a cost of debt (pre tax) of 8%. The yield on 8 years treasury bonds is 5% while current market risk premium stands at 6%. The company's historical beta (that it is likely to sustain) is 1.2.

Required

1). Given this information, you are required to determine if MS should proceed with this project. Base your answers on computing net present value and internal rate of return.

2). Assume that the new product is totally unrelated to the existing product line and firm feels that this may require a premium to the existing cost of capital. If the anticipated premium to the cost of capital is 100 basis points, what will be your decision about the feasibility of new product?

3). What should be the maximum premium on the exiting cost of capital after which the new product will not remain feasible?