QUESTION 4

New Furnishing Ltd is considering a new line of office chairs and has employed a marketing consultant for $50,000 to report on the viability of the new product.

The company expects that this range of chairs will be sold on average at $45 per chair in the first year and they will be able to sell 25,000 chairs per year. Whilst unit sales are expected to remain at the same level for the projects 5 year life, price per chair over the life of the project is expected to increase at the long-term rate of inflation (estimated at 2.15%) per year. The cost of raw material and packaging will be $17.50 per chair in the first year and the company expects this cost will increase by 0.25% more than the rate of inflation per year. Other variable costs are expected to be 7% of total sales per year and fixed costs are estimated to be $385,000 per year.

If the company proceeds with this project it would need to extend their manufacturing facility at an estimated cost of $1,000,000 and the new equipment will cost another $1,000,000. The extended part of the facility and the equipment will be depreciated on a straight-line basis to zero salvage value over the 5 year life of the project. It is estimated the various components of equipment can be sold for $300,000 at the completion of the project. Assume all cash flows relating to sales and costs are received or made at the end of each year.

As a financial manager of the company, youre conducting a capital budgeting analysis of the financial viability of the new model.

Companys required payback is 3 years and required rate of return is 12%. The company tax rate is 30%.

1. Calculate the incremental cash flows for each year (Y₀ to Y₅ inclusive).

2. Calculate the payback period of the project. (Show answer correct to four decimal places)

3. Calculate the net present value, that is, the net benefit or net loss in present value terms of the project. (Show answer correct to the nearer cent)

4. Calculate the present value index of the project. (Show answer correct to four decimal places)

5. Calculate the discounted payback period of the project. (Show answer correct to four decimal places)

6. Calculate the internal rate of return of the project. (Show answer correct to four decimal places)

7. You are concerned that the company may not be able to sell 25,000 chairs per year. You believe they may only be able to sell 20,000 chairs per year. Calculate the incremental cash flows each year (Y₀ to Y₅ inclusive) and NPV of the project if only 20,000 chairs can be sold (all other assumptions are unchanged). (Show answer correct to the nearer cent)

8. Identify and discuss any further information that the company may require to help make the accept/reject decision about this project. (Maximum 250 words).

1. Explain if the company should accept this project or not.