Rugged Outdoor Supplies is looking to expand its business. The new business is expected to generate $2.6 million per year in sales over the next 5 years. Annual costs would increase by $2.1 million. Both sales revenues and costs are expected to increase by 2% per year due to inflation. An investment in working capital of $65,000 would have to be made initially. The machinery (CCA rate of 30%) would cost $635,000, with additional costs of $25,000 to be incurred for setup and training. They also estimate that it would be possible to sell the equipment for 15% of its initial value at the end of 5 years. The company would set up operations in a building it does not use but currently rents out for $80,000 flat per year. If the firm's cost of capital is 8% and its tax rate is 29%, should it proceed with this new business? Sales Annual incremental costs Inflation Investment in NOWC CCA rate Equipment cost Setup & Training Salvage value rate Econpmic life Opportunity cost Cost of Capital Tax rate A. Input Data 2,600,000 2,100,000 2.00% 65,000 30.00% 635,000 25,000 15.00% 80,000 8% 29% $ Equipment cost Setup and training Investment in NWC B. Initial Investment 635,000 25,000 65,000 725,000 $ Yr 1 2 3 4 5 Sales Less forgone rental Income Costs Project cash flows before tax Tax Project cash flows after tax C. PV of Cash Flows After Tax D. PV of CCA tax shield formula (if asset class remains open after asset is sold) SdTV 1 CdT1+0.5r PV= r+d 1+r 635,000 C = Capital Cost $ d = CCA rate for asset class T = Corporate tax rate r=cost of capital rate S = Salvage value of asset n=#years D. PV of CCA Tax Shield Salvage value Return of NWC Total ending cashflow E. PV of Total Ending Cashflows F) Putting it together Initial Investment PV of Cash Flows After Tax PV of CCA Tax Shield PV of Ending Cash Flows NPV Summary: Proceed with the Project? Why: Why are interest and sunk costs not included but opportunity costs and externalities are included in the NPV approach to project analysis