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Capital budgeting to decide whether to accept-reject project

Problem:

Superior Manufacturing is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 55% of sales. Indirect incremental costs are estimated at $80,000 a year. The project requires a new plant that will cost a total of $1,000,000, which will be depreciated straight line over the next five years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000. Assume there is no need for additional investment in building and land for the project. The firm's marginal tax rate is 35%, and its cost of capital is 10%. Based on this information you are to complete the following tasks.

1. Prepare a statement showing the incremental cash flows for this project over an 8-year period.

2. Calculate the Payback Period (P/B) and the NPV for the project.

3. Based on your answer for question 2, do you think the project should be accepted? Why? Assume Superior has a P/B (payback) policy of not accepting projects with life of over three years.

4. If the project required additional investment in land and building, how would this affect your decision? Explain.

1. Create an Incremental Cash Flow schedule for years one to eight.

2. Input year zero values for:

a. Initial investment

b. Net Working Capital

3. Compute and enter the Operating Cash Flows for years

a. 1

b. 2 to 5

c. 6 to 8

4. Get the total cash flow for each year

5. Compute the Net Present Value

6. Compute the Payback Period

7. Use the Capital Budgeting Techniques (NPV & Payback) to decide whether the project should be accepted or rejected.

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