Tracy Inc. is a sneaker manufacturer. Having spent $120,000 on market research, the firm finds a new line of sneaker promising and contemplates making new investments on it. For further evaluation, Tracy Inc. has gathered the following investment and operational data for the new sneaker product line,

New Equipment

It costs $14,000,000.

5 years economically useful life with zero salvage value.

Depreciation is calculated on the straight-line basis.

Net Working Capital (NWC)

Incremental investment in NWC at the beginning of the project is $1,000,000.

New Sneaker Product

45,000 pairs of new sneakers will be sold every year in the next 5 years.

Each pair of new sneaker will be sold for $700.

Variable cost is $320 per pair.

Fixed cost (excluding depreciation) per year is $7,500,000. Existing Sneaker Product

The launch of new sneaker product would lower the sales volume of existing sneaker product by 13,000 pairs per year in the next 5 years.

Sales price and variable cost for each pair of existing sneaker product are $500 and $280 respectively.

a. With 40% corporate tax rate, calculate the amount of initial outlay, operating cash flow per year and terminal cash flow of the new sneaker project. State the total after-tax cash flow for the project from year 0 to year 5. (25 marks)

b. Assume 15% required rate of return, calculate the NPV, IRR, payback and the profitability index of the new sneaker project. Taking all the indicators into consideration, should Tracy Inc. invest in the new project (Assume the payback should not exceed 3 years)? (15 marks)

c. Tracy Inc. finds that the sales volume assumption of 45,000 pairs for the new sneaker in year 5 is too optimistic. After plugging in a lower but more reasonable assumption in the cash flow forecast, the firm finds that the total after-tax cash flow in year 5 turns negative, and therefore it plans to re-evaluate the project. Without doing any calculation, explain if it is appropriate for Tracy Inc. to use IRR method to re-evaluate the project. (10 marks)