The Ventilation Division will manufacture the IAFS using idle facilities. This plant can produce up to 250 units per year over the product’s 10-year life. An outside appraiser indicated that the plant is worth $2,750,000, which breaks down as $1,500,000 for the land and $1,250,000 for the building. New production equipment costing $5,600,000 is also required. It is believed that the land will have a residual value of $1,600,000 at the end of the project’s life, while the building and equipment will be worth $400,000 and $300,000. The building is subject to a CCA rate of 4.0% and the equipment is subject to a CCA rate of 20.0%. Incremental net working capital of $600,000 is also needed which will be liquidated at the end of the product’s life.

APSI sales are estimated to be 80 units in the first year and will grow by 10.0% a year until plant capacity is reached. The unit price is $140,000 and unit costs are $113,500 per unit, which includes direct materials, direct labor, and manufacturing overhead. The Ventilation Division must also pay a $10,000 licensing fee per unit for the vacuum cleaner technology. Incremental selling and administration costs will be $400,000 per year.

Automated Paving Stone Installer (APSI) Projections

A new factory is needed to manufacture the APSI. The facility can produce up to 250 machines each year over the product’s 15-year life. A parcel of land worth $650,000 will be purchased, and a building constructed for $1,950,000. Equipment costing $4,200,000 is also be required. At the end of the project’s life, it is estimated the land can be sold for $780,000, while the building will have a residual value of $850,000 and the equipment’s residual value will be negligible. Building and equipment costs are subject to CCA rates of 4.0% and 20.0% respectfully. An investment of $650,000 in net working capital is needed to support products that will be liquidated at the end of the product life.

APSI sales are forecasted to be 50 units in the first year, 100 in the second year, 150 in the third year, 200 in the fourth year, and then reach a factory capacity of 250 units in the fifth year. The product’s list price is $255,000 and its unit cost is $238,500, which includes direct materials, direct labor, and factory overhead. Incremental selling and administration costs to support the business will be $1,870,000. The existing corporate overhead of $220,000 per year will be allocated to the product as per company policy. Factory equipment will be overhauled at a cost of $1,400,000 at the end of year 8.

Discount Rate

In the past, MDFA used a corporate cost of capital to evaluate the feasibility of its new product proposals. Denison felt this rate was inaccurate as it reflected the weighted-average cost of capital of the three MDFA divisions. The Ventilation Division likely has a higher cost of capital since its products are sold primarily to private-sector companies with greater exposure to the business cycle. In comparison, the Surfaces Division likely has a lower cost of capital as it sells its products primarily to city and municipal governments with relatively stable tax revenues and public works budgets. To be more precise, Denison decided to use divisional costs of capital to evaluate each project.

To determine the cost of capital for the Ventilation Division, Denison collected information on the betas and credit spread on Treasuries for five public companies in the industry:

Company	Beta	Treasury Spread
Rapid Flow	1.51	6.11%
Environmental Systems	1.36	4.52%
Clean Air	1.42	4.89%
CirculVent	1.48	5.04%
Pure Air	1.33	4.13%

For the Surfaces Division, MDFA only has one publicly-traded North American company for comparison. Dura Surface Ltd. has been in existence for 30 years selling road and sidewalk surfacing machinery. Exhibit 1 provides share prices for Dura Surface and national stock index values for the last five years. Dura Surface issues bonds to finance its operations, which currently trade at 101.11 and have a coupon rate of 5.44% and a term of 14 years with a semiannual payment.

Due to its strong financial position, MDFA is able to raise new capital inexpensively. Retained earnings are used instead of new equity to fund growth to avoid control problems, and the cost of raising debt is negligible. For that reason, the company policy is not to include issuance costs in the costs of capital or to calculate them in the cash flows.

The interest rate on the 20-year Government of Canada bond is currently 2.2% and the market risk premium is 6.0%. MDFA has a marginal tax rate of 25.0% and a long-term debt to total capitalization ratio of 30.0% which approximates the company’s target capital structure.

Calculate Cost of capital and NPV for IAFS AND APSI.