Problem 11-20

The Ebitts Field Corp. manufactures baseball gloves. Charlie Botz, the company's top salesman, has recommended expanding into the baseball bat business. He has put together a project proposal including the following information in support of his idea.

• New production equipment will cost $75,000, and will be depreciated straight-line over five years.
• Overheads and expenses associated with the project are estimated at $20,000 per year during the first two years and $40,000 per year thereafter.
• There is enough unused space in the factory for the bat project. The space has no alternative use or value.
• Setting up production and establishing distribution channels before getting started will cost $300,000 (tax deductible).
• Aluminum and wood bats will be produced and sold to sporting goods retailers. Wholesale prices and incremental costs per unit (direct labor and materials) are as follows.

  Aluminium	Wood
  Price	$18	$12
  Cost	11	9
  Gross Margin	$7	$3

• Charlie provides the following unit sales forecast (000).

  Year
  1	2	3	4	5	6
  Aluminium	6	9	15	18	20	22
  Wood	8	12	14	20	22	24

• The sixth year sales level is expected to hold indefinitely.
• Receivables will be collected in 30 days, inventories will be the cost of one month's production, and payables are expected to be half of inventories. Assume no additional cash in the bank or accruals are necessary. (Use one-twelfth of the current year's revenue and cost for receivables and inventory, respectively)
• Ebitts Field's marginal tax rate is 40% and its cost of capital is 14%.

1. Develop a six-year cash flow estimate for Charlie's proposal. Round the answers to the nearest dollar.

   Year	Cash Flow
   1	$
   2	$
   3	$
   4	$
   5	$
   6	$

2. Calculate the payback period for the project. Round your answer to one decimal place.Payback Period =year(s)
3. Calculate the project's NPV, assuming a six-year life. Round your answer to the nearest dollar. Use a minus sign to indicate a negative NPV. Do not round your intermediate calculations.NPV = $ Is the project acceptable?no
4. Is the cost of capital an appropriate discount rate for the project considering its likely risk relative to that of the rest of the business?yes
5. What is the project's NPV if the planning horizon is extended to eight years? Round the answer to the nearest dollar. (Add the incremental PV from two more years at year 6's cash flow.) Do not round your intermediate calculations.$
6. What is the NPV if management is willing to look at an indefinitely long time horizon? Round the answer to the nearest dollar. (Hint:Think of the cash flows in years 6 and beyond as a perpetuity.) Do not round your intermediate calculations.$