The XYZ Company is a division of ABC Ltd. which requires each of its divisions to achieve a payback period less than 3 years for all the new projects. XYZ needs to increase production capacity to meet increasing demand to an existing product Bingo, which is used in food processing.

The capital cost for the new project, with a useful life of 4 years and a maximum output of 600,000kg of Bingo per year, is $800,000. The salvage value is expected to be $80,000 at the end of 4 years. XYZ spent $20,000 in a marketing survey last year and the results reveal the following forecast new demand over the 4 years:

Year	1	2	3	4
New Demand(kg)	350,000	400,000	480,000	700,000

The selling price for year 1 is expected to be $2/kg and it will increase by 10% each year. The variable cost is estimated to be 60% of the selling price. The fixed cost (including maintenance cost and excluding depreciation) is estimated to be $100,000 in year 1 and it will increase by $20,000 per year.

Other information: The company pays tax at 20%. Depreciation is charged on a straight-line basis.

Requied:

a. Determine the after-tax operating profit and operating cash flows for the project over its useful life.

b. Calculate the project's payback period and comment on the major disadvantages of this capital budgeting decision criterion. Determine whether the expansion project will be accepted based on the payback.

c. The CFO of ABC suggests using NPV method to evaluate investment in new project and estimate the cost of capital to be 10% for expansion project of XYZ. Calculate the project's NPV and determine whether XYZ should accept the expansion project.

d. Explain why sunk costs should not be included in capital budgeting analysis, but opportunity costs and side effects (externalitied) should be included. Given an example of each.