Benjamin Corp. is considering expanding into the sports drink business with a new product. Assume that you were recently hired as assistant to the director of capital budgeting and you must evaluate the new project.
The sports drink would be produced in an unused building adjacent to Benjamin's Arizona plant; Benjamin owns the building, which is fully depreciated. The required equipment would cost $750,000, plus an additional $50,000 for shipping and installation. In addition, inventories would increase by $50,000, while accounts payable would increase by $20,000. All of these costs would be incurred today. The equipment will be depreciated by the straight-line method over the life of the project.
The project is expected to operate for 8 years, at which time it will be terminated. The cash inflows are assumed to begin 1 year after the project is undertaken and to continue until the end of the eighth year. At the end of the project's life, the equipment is expected to have a salvage value of $100,000.
Unit sales are expected to total 1,200,000 units per year, and the expected sales price is $3.50 per unit. Cash operating costs for the project (total operating costs less depreciation) are expected to total 70% of dollar sales. Benjamin's tax rate is 40%, and its WACC is 15%. Tentatively, the sports drink project is assumed to be of equal risk to Benjamin's other assets. You have been asked to evaluate the project and to make a recommendation as to whether it should be accepted or rejected.
Required:
Using net present value recommend whether or not Benjamin should purchase the new equipment.