Anderson Technologies is considering expanding into a new product line. The new product line is estimated to produce new sales of 100,000 units at $2 per unit. The project requires the purchase of new equipment that will cost $240,000 including shipping costs and installation. The company’s controller has determined that equipment is in the MACRS 3-year class life. Management believes the assets will have an economically useful life of four years and be salvageable at that time for $25,000. Taking on the project will require the firm to increase inventories by $25,000. The new inventories will be partially financed by suppliers as account spay able would be expected to increase by $5,000. Operating costs (variable plus fixed costs excluding depreciation) are estimated to be 60% of sales, so the operating margins look attractive. But the firm’s CEO needs to know if these incremental profits are sufficient to justify spending the money up front on the project when the firm’s WACC is 10%. Help the CEO evaluate the project.
a) Determine the initial investment in the project.
b) Determine the annual depreciation expense on the fixed investment using the MACRS depreciation table for 3-year property.
c) Determine the operating cash flows over the project’s life.
d) Determine the terminal cash flow for the project in year four.
e) Should Anderson open this new product line?