Question Background

After spending $500,000 last year to study the potential market for a new specialty chemical, Stark Industries is considering a new plant requiring an initial investment in new construction and equipment.

- The projected has an anticipated economic life of five years

- The firm purchased the land to build this plant at a cost of $500,000 three years ago. The land now (i.e. year 0) has an after tax market value of $400,000 It will be used in this project

- The company will purchase $6,000,000 in new plant and equipment. The IRS will allow Stark to depreciate the plant and equipment to a salvage value of zero on straight-line basis over a six-year useful life.

- The firm estimates revenue will be $22 million per year for each of the next 5 years, beginning in year 1

- Fixed costs for the project are estimated to be $3,000,000 annually.

- Stark's oppurtunity cost of captal is 15% and their average tax rate is 35% and their marginal tax rate is 30%

- Assume all the company's revenue has a variable cost of 60% of revenue

- Interest expense related to borrowing for the project is $500,000 per year

- Startup net working capital requirements for the project are expected to be $1million. The net working capital requirements will be $1million annually from year 1 to 5. At the end of the 5-year project, the initial investment in net working capital will be recovered

- The new product is expected to increase the after tax sales of the company's existing products by $250,000 a year

- At the end of the project, they expect to be able to sell the plant and equipment for $2million

Required (show work):

a) What is the IRR of this project

b) What is the NPV of this project

c) Should you accept this project and why?