Question
The SPO Corporation, a firm in the 25% marginal tax bracket, with an 18% required rate of return or discount rate, is considering a new
The SPO Corporation, a firm in the 25% marginal tax bracket, with an 18% required rate of return or discount rate, is considering a new project. This project involves the introduction of a new product. This product is expected to last 5 years and then, because it is somewhat of a fad product, it will be terminated.
Cost of new plant and equipment: $220,000,000
Shipping and installation costs: 5,000,000
Unit sales:
Year Units Sold:
Year 1: 2,000,000
Year 2: 2,000,000
Year 3: 2,000,000
Year 4: 1,000,000
Year 5: 1,000,000
Sales price per unit: $800/unit in years 1-3; $600/unit in years 4 and 5 Variable cost per unit: $400/unit Annual fixed costs: $10,000,000
There will be an initial working capital requirement of $2,000,000 just to get production started. At the conclusion of the project, the plant and equipment can be sold for $25,000,000. The plant and equipment will be depreciated over five years on a straight- line basis to a zero-salvage value.
Solve:
a) Determine the net present value of the project.
b) Determine the payback period of the project.
c) Determine the internal rate of return of the project.
d) Do you recommend that the project be undertaken? Explain
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