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XYZ Ltd. is planning to introduce a new product with a project life of eight years. The project is to be set up in Special
XYZ Ltd. is planning to introduce a new product with a project life of eight years. The project is to be set up in Special Economic Zone (SEZ), qualifies for one-time (at starting) tax-free subsidy from the state government of $2,500,000 on capital investment. Initial equipment cost will be $17,500,000. Additional equipment cost of $1,250,000 will be purchased at the end of the third year from the cash inflow of this year. At the end of eight years, the original equipment will have no resale value, but additional equipment can be sold for $125,000. A working capital of $2,000,000 will be needed and it will be released at the end of the eighth year. The project will be financed with sufficient amount of equity capital. The sales volumes over eight years have been estimated as follows: The sales price of $120 per unit is expected and variable expenses will amount to 60% of sales revenue. Fixed cash operating costs will amount to $1,800,000 per year. The loss of any year will be set off from the profits of subsequent two years. The company is subject to 30% tax rate and considers 12% to be an appropriate after tax cost of capital for this project. The company follows the straight-line method of depreciation. Required: Calculate the NPV of the project and advise the management to take appropriate decision. Note that the PV factors at 12% are
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