Question 3 - Capital Budgeting and Project Cash Flows

A.

You are considering the manufacture of new confidence boost supplement and you believe you can sell 5,000 of these per year for five years (after which time this project is expected to shut down when it is learned that being fit is unhealthy).

The supplement would sell for $1,000 each with variable costs of $500 for each one produced, and annual fixed costs associated with production would be $1,000,000. In addition, there would be a $5,000,000 initial expenditure associated with the purchase of new production equipment.

It is assumed this initial expenditure will be depreciated using simplified straight-line method down to zero over five years. This project will also require a one-time initial investment of $1,000,000 in net working capital associated with inventory, and it is assumed this working capital investment will be recovered when the project is shut down.

Finally, assume the firms tax rate is 30%.

1. What is the initial outlay associated with this project?

2. What is the internal rate of return?

3. What is the projects NPV given a 10% required rate of return?

4. Would you accept or reject the project? Explain your reasoning.
5. If the machine was sold for $1.5 million at the end of the project, should you invest given a required rate of return of 10%?