Question
The Zeus Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine
The Zeus Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0. The cane manufacturing machine will result in sales of 2,000 canes in year 1. Sales are estimated to grow by 10% per year each year through year three. The price per cane that Zeus will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each. Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts (note: these accounts increase when the machine is installed). It is estimated that the Zeus Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivables, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 35% tax bracket, and has a cost of capital of 10%. Construct an income statement similar to the one below and answer the following questions. (Be sure you show the income statement).
(a) What is the incremental EBIT in the first year?
(b) What is the incremental unlevered net income in the first year?
(c) What is the depreciation tax shield in the first year?
(d) What is the amount of incremental income taxes that the Zeus Corporation will pay in the first year on this new project?
(e) What are the corresponding quantities in (a) through (d) above in year 2?
(f) What are the corresponding quantities in (a) through (d) above in year 3?
(g) What is the required net working capital (NWC) in the first year?
(h) What is the required NWC in the second year?
(i) What is the change in NWC from year one to year two?
(j) Calculate the total Free Cash Flow for each of the three years.
(k) Calculate the projects NPV. Should the project be undertaken?
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started