Question $15$

You have been hired as a financial analyst for Cuboose Inc. $($CUBE$).$ Cuboose manufactures leather products and has recently completed the design and specifications for a fine leather chair. The market for these chairs is growing quickly.

The company also hired a marketing firm to analyse the leather chair market, at a cost of $$275,000.$ An excerpt from the marketing report is as follows: $$The leather chair industry will have a rapid expansion in the next four years. With the brand name recognition associated with Cuboose Inc., we believe that the company will be able to sell $5,000,6,000,6,500,$ and $5,000$ units each year for the next four years, respectively. Again, given the brand recognition of Cuboose Inc., we also believe that a premium price of $$425$ can be charged for each leather chair. Lastly, since it appears that these leather chairs are a fad, we feel at the end of the four years, sales of this product should be discontinued.

You have researched the cost elements of the firm and believe that fixed costs for the project will be $$350,000$ per year, and variable costs will be twenty percent $(20\%)$ of sales. The equipment necessary for the production of the leather chairs will cost $$4,000,000$ and will be depreciated on a straight$-$line basis. At the end of the project, the equipment can be scrapped for $$250,000.$ Net working capital of $$350,000$ will be required immediately and Cuboose falls into the twenty percent $(20\%)$ corporate tax rate category. Cuboose management has a ten percent $(10\%)$ cost of equity and a fifteen $(15\%)$ cost of capital.

Requked:

Calculate the net present value of the project and advise whether the investment is financially acceptable. $(11$ marks$\}$

Calculate the internal rate of return of the project and advise whether the investment is financially acceptable. $(3$ marks$)$

Calculate the discounted pay$-$back period of the project and advise whether the investment is financially acceptable. Cuboose's management has set a cut$-$off period of three $(3)$ years for all new projects. $(4$ marks$)$

Write a short memo to Cuboose's management advising of two $(2)$ disadvantages associated w'ith the discounted pay$-$back period investment appraisal approach. $(2$ marks$)$