Assignment 1 (CB) FALL2014: Project Q involves purchase of machinery which will support production

Assignment 1 (CB): Project Q involves purchase of machinery which will support production of a new product. If the machine is purchased, we expect to sell 5,500 units per year for FOUR years at a price of $1275 per unit. Variable Costs to produce each unit are estimated to be $ 475. Fixed manufacturing and overhead costs are estimated at $635,000 per year.

The machinery will cost $1,325,000; which cost will be depreciated for TAX PURPOSES as a seven year MACRS asset. Company management believes that the machinery can be sold for $500,000 at the end of the project.

Producing the new product will require an initial (Yr0) investment in Net Working Capital (NWC) of $ 1,100,000. During the project life annual NWC requirements are expected to be 25% of Sales. The company expects to recover 60% of its NWC project investments at the end of the project.

Assume a 40% aggregate tax rate and a required rate of return of 20%. Should the company undertake this project?

First prepare a Depreciation Schedule:

Yr Depreciation Expense Book Value

1

2

3

4

Next prepare projected Annual Income Statements:

Yr1 Yr2 Yr3 Yr4

Sales

VC

FC

EBITDA

Depn

EBIT

Taxes @ 40%

NI

Calculate OCF:

NI

+Depn

OCF

Non-operating CFs:

NWC Yr0

NWC Yr4

CAPEX (Capital Spending)(CS):

CS Yr0

CS Yr4 (consider After-tax Salvage Value)

Total Cash Flows (TCFs)

Yr0 Yr1 Yr2 Yr3 Yr4

OCF

CS

NWC

TCF

What is the project’s Payback (PB) period?

What is the project’s Net Present Value (NPV)?

What is the project’s IRR?