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?
