Remark: all the dollar value below should be considered fair (true) market values i.e. any prospective buyer/seller would gladly pay them]

A small (but very profitable) multi-product toy company is considering the following project:

For the next 8 years, the company would be producing a new special toy. For the first three years, the company is expected to sell 3,100 products per year. For years 4 to 8, the company is expected to sell 14,900 products per year.

The price per product is expected to be $26 the first year; and the price is expected to increase 5% per year thereafter. The variable costs are expected to be 60% of the revenues every year. In addition, the company is expected to pay fixed costs (production facility leasing) of $72,000 per year.

The project requires TWO initial capital investments: The Stage 1 small production line will cost $51,000. The value of this investment is to be depreciated straight-line to zero over 3 YEARS, with the first depreciation charge coming during Year 1. It is expected that Stage 1 production line can be sold in Year 3 for the (salvage) price of $7,500. Stage 2 big production line will be bought in Year 2. The cost of the investment is supposed to be $210,000. The value of this investment is to be depreciated straight-line to zero over 10 YEARS, with the first depreciation charge coming during Year 3 (note: even though the project takes only 8 years, it is very well possible that the time of depreciation may be completely different from the maturity of the project.). It is expected that the capital investment can be sold in Year 8 for the (salvage) price of $65,000.

Initial net working capital (NWC) investment is $4,800 (to be paid immediately). After that, the annual NWC levels are supposed to grow by $500 per year.

The tax rate is 35% and the required rate of return is 14%.

The project was identified with the help of the employee of the company. To compensate her for the time spent on the project analysis, the employee has a contract that mandates the company to pay her $10,000 immediately. In addition, if the project is undertaken, the employee will receive a one-time bonus of $8,000 payable during Year 1 of the project (both payments are tax-deductible for the company).

If the company decides to undertake the project, what are the levels of total cash flows associated with the projects in years 0 through 8?

Should the project be undertaken based on NPV rule?

Should the project be undertaken based on IRR rule?

Assume a little different scenario: the company will not have to pay any of the $72,000 fixed (production facility leasing) costs in cash, because the company will undertake the project in the facilities already owned by the company.

What is the projects NPV under these new circumstances? Should the company undertake the project in this case? Why or why not?

Go back to the original project you analyzed in parts A through C. Consider this scenario: IF the company decides to produce the NEW toy, the increased press coverage of the company will make all the EXISTING products of the company more popular. It can be estimated that the (total) FCF generated by the EXISTING products of the company would increase by $12,000 per year for Years 1 through 8, if the new toy is introduced. What is the projects NPV under these new circumstances? Should the company undertake the project in this case? Why or why not?