Question
Shoe manufacturing line. A company is evaluating an investment in a new shoe manufacturing line. To start the project, the company would buy equipment for
Shoe manufacturing line. A company is evaluating an investment in a new shoe manufacturing line. To start the project, the company would buy equipment for $15.5 million and spend $750,000 on installation. The company expects to shut down the shoe manufacturing line at the end of year 5, at which point the equipment is likely to be worthless. In light of this, the company will depreciate the equipment straight line to $0 over 5 years. Assume that the tax rate is 21%. The following information about this project is given to you by the CEO of the company:
- The company expects to manufacture and sell 65,000 pairs of shoes in year 1. This number is expected to grow at 3.5% per year up to year 5.
- The sales price for a pair of shoes is expected to be $150 in year 1 and to grow at 2.5% per year.
- The per unit variable cost of production for a pair of shoes in year 1 is projected to be $35 and this figure is projected to grow at 3% per year.
- The company will incur annual fixed costs of $850,000 if it accepts this project.
- In order to store the manufactured shoes, the company has to use its warehouse. If this project is rejected the warehouse can be leased for $135,000 per year for 5 years. This would be a pre-tax revenue stream.
- The company expects that the production of this new model of shoes will decrease the sales of older models manufactured by the company, leading to an after-tax cash flow reduction of $200,000 per year.
- This project needs an initial investment of $1.5 million in non-debt working capital, which will be returned at the end of the year 5.
Part 1: What is the projected earnings before interest and tax (EBIT) in forecast year 5 associated with this project? Ignore the $200,000 after-tax cash flow impact from lower sales volume of older models.
Group of answer choices
a. $4.4 million to $4.6 million
b. $4.6 million to $4.8 million
c. $4.8 million to $5.0 million
d. $5.0 million to $5.2 million
e. $5.2 million to $5.4 million
f. $5.4 million to $5.6 million
g. $5.6 million to $5.8 million
h. $5.8 million to $6.0 million
i. $6.0 million to $6.2 million
j. $6.2 million to $6.4 million
Question 1, Part 2: If the required cost of capital is 12%, what is the net present value of this project?
Group of answer choices
a. $4.4 million to $4.6 million.
b. $4.6 million to $4.8 million
c. $4.8 million to $5.0 million
d. $5.0 million to $5.2 million
e. $5.2 million to $5.4 million
f. $5.4 million to $5.6 million
g. $5.6 million to $5.8 million
h. $5.8 million to $6.0 million
i. $6.0 million to $6.2 million
j. $6.2 million to $6.4 million
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