Question1:
- ABC Corporation is considering an expansion project. The proposed project has the following features:
The project has an initial cost of $1,000,000 (machine: $800,000, insurance: $40,000, shipping $60,000, modification: $100,000) --this is also the amount which can be depreciated using the following 3 year MACRS depreciation schedule:
Year Depreciation Rate
1 33%
2 45
3 15
4 7
- The sales price and cost are both expected to increase by 4 percent per year due to inflation.
- If the project is undertaken, net working capital would have to increase by an amount equal to 10% of sales revenues. This net operating working capital will be recovered at the end of the project's life (t = 4). (You must consider an inflation effect.)
- If the project is undertaken, the company will selladditional 100,000 units in the next three years (t = 1, 2, 3, 4). Unit price at the end of the Year 1 is $10.
- The company's operating cost (not including depreciation) will equal to 50% of sales.
- The company's tax rate is 40 percent.
- The company has no debt.
- At the end of Year 4, the project's economic life is complete, but the company can sell the machine at $20,000 (market value of salvage).
- The project's WACC = 8 percent.
What is the project's net present value (NPV)?
Question2:
Nebraska Instruments (NI) is considering a project that has an up-front after tax cost at t = 0 of $1,000,000. The project's subsequent cash flows critically depend on whether its products become the industry standard. There is a 70 percent chance that the products will become the industry standard, in which case the project's expected after- tax cash flows will be $900,000 at the end of each of the next three years (t = 1,2,3). There is a 30 percent chance that the products will not become the industry standard, in which case the after-tax expected cash flows from the project will be $200,000 at the end of each of the next three years (t = 1,2,3). NI will know for sure one year from today whether its products will have become the industry standard. It is considering whether to make the investment today or to wait a year until after it finds out if the products have become the industry standard. If it waits a year, the project's up-front cost at t = 1 will remain at $1,000,000 (certain cash flow). If it chooses to wait, the estimated subsequent after-tax cash flows will remain at $900,000 per year if the product becomes the industry standard, and $200,000 per year if the product does not become the industry standard. There is no penalty for entering the market late. Assume that all risky cash flows are discounted at 8 percent and risk-free rate is 5 percent.
1) What is the expected NPV of the project if NI proceeds today?
2) If NI chooses to wait a year before proceeding, what will be the project's new NPV?