WMart is considering offering one hour photo developing in their store. Assume the project

of providing the new service has a life of 5 years and the firm expects that sales from the

new service will be $100,000 per year. WMart currently offers overnight film processing

with annual sales of $80,000. While many of the one hour photo sales will be to new

customers, WMart estimates that if the company starts the new service, 60% of their current

overnight photo customers will switch to the new service. If the company fails to provide

the new service, half of the switching customers (i.e. 60% of the current customers) will

switch to a competitor for similar service. Further, lets assume the new service has no

impact on the cost of the existing overnight film processing service.

The company need to purchase a new photo machine for the new service at a cost of

$15,000. For tax purpose, assume straight line depreciation, and the equipment will be

obsolete after 5 years.

For the new one hour photo service, the company will need to train two staff to operate the

machine, which will result in an upfront cost of $1,500. In addition, there is an annual

maintenance expense of $5,000 when the machine operates.

WMart has a cost of capital of 10%. Consider no change in net working capital associated

with the project. Assume the marginal tax rate is 40% and all cash flows occur at year end.

a) What are the free cash flows of the project? (6 marks)

b) Calculate the NPV of the project. Should the company invest or not? Why? (4 marks)