Question 6 (Capital Budgeting)

You are a financial manager for BPI Inc. and are asked to evaluate a potential investment opportunity by the senior manager of the R&D division. Key information about the project is given in the table below. Additional information is as follows:

The project wont generate any revenues, costs of goods sold, or SG&A expenses after year 3.

It will take a team of 10 engineers 3 months to get the project started. Engineers at BPI are typically paid upfront for projects and the average monthly salary of an engineer working for BPI

is $8,500. The salary of the engineers is considered an R&D expense.

The project will require an upfront investment in additional machinery of $600,000 today. The

machinery will be depreciated over 4 years using straight line depreciation starting at the end of

year 1.

In year 4 the machinery will need to be disposed of, which will generate a disposal cost of $50,000

that can be expensed for tax purposes.

The marginal tax rate of BPI is 21% and BPI as a firm is expected to generate at least $10 million

of pre-tax income each year for the next six years, regardless of whether it takes the new project

or not.

The appropriate interest rate to discount free cash flows is 11%

A midyear adjustment is not necessary.

To get more information about the project you have a meeting with the senior manager of the R&D division. In that meeting you learn that the R&D division has already built a prototype for this project in order to determine its feasibility and that the prototype cost $200,000 to develop. Moreover, you are being told that BPI will not hire additional engineers but will use in-house engineers that are currently employed by BPI. The senior manager of R&D claims that using in-house engineers will help increase the profitability of the project since they are already on the companys payroll.

Question 6 (Capital Budgeting) You are a financial manager for BPI Inc. and are asked to evaluate a potential investment opportunity by the senior manager of the R\&D division. Key information about the project is given in the table below. Additional information is as follows: - The project won't generate any revenues, costs of goods sold, or SG\&A expenses after year 3. - It will take a team of 10 engineers 3 months to get the project started. Engineers at BPI are typically paid upfront for projects and the average monthly salary of an engineer working for BPI is $8,500. The salary of the engineers is considered an R\&D expense. - The project will require an upfront investment in additional machinery of $600,000 today. The machinery will be depreciated over 4 years using straight line depreciation starting at the end of year 1. - In year 4 the machinery will need to be disposed of, which will generate a disposal cost of $50,000 that can be expensed for tax purposes. - The marginal tax rate of BPI is 21% and BPI as a firm is expected to generate at least $10 million of pre-tax income each year for the next six years, regardless of whether it takes the new project or not. - The appropriate interest rate to discount free cash flows is 11% - A midyear adjustment is not necessary. To get more information about the project you have a meeting with the senior manager of the R\&D division. In that meeting you learn that the R\&D division has already built a prototype for this project in order to determine its feasibility and that the prototype cost $200,000 to develop. Moreover, you are being told that BPI will not hire additional engineers but will use in-house engineers that are currently employed by BPI. The senior manager of R\&D claims that using in-house engineers will help "increase the profitability of the project since they are already on the company's payroll