Whitehaven Group Ltd (WHG) is an industrial machinery manufacturing company based in Sydney. Due to increased demand for the companys products the CEO of WHG, Mr John Johnson, is looking at upgrading the companys production facilities at Chullora. As the member of the finance department at WHG you have been assigned the task of assessing the acceptability of the new project.

To assist you in this task the finance team have prepared the following information relating to the proposed project:

Implementation of the new project would require an immediate outlay of $10,000,000 on new machinery. This machinery is depreciable for tax purposes.

Additionally, WHG would need to undertake an immediate upgrade of the warehouse used for the project. This upgrade would cost $2,500,000 and is not considered depreciable for tax purposes.

The project is expected to have an operational life of four years.

The project is expected to generate EBDIT (in nominal values) of $5,000,000 in the first year of operation.

EBDIT is expected to increase in line with inflation, which is forecast to be 4.5% p.a.

Yesterday WHG paid a consultant $200,000 to undertake the market research used to generate the figures used in evaluating this project.

The Australian Tax Office has ruled that a 40% p.a. depreciation rate is appropriate for this project.

The project is expected to require a working capital outlay of $400,000 upon implementation. Working capital needs are then expected to increase in line with inflation. All working capital will be fully recovered at the end of the project.

Presently WHG is renting out the warehouse space that would be used for this project, so if the project proceeds the rental agreement will need to be cancelled. The rent income this year amounted to $650,000. Rental income was expected to remain constant over the life of the project.

At the end of the project WHG anticipates that the machinery could be sold for $4,000,000 if technology has not changed during that time. If technology has changed over the life of the project, then the machinery will be worthless at the end of the life of the project. WHG believe that there is a 50% change of each of these outcomes occurring.

The company tax rate is 30%.

The required rate of return of the project is 11.33%pa.

Is the project acceptable?