Problem: A company wants to invest 40,000,000 in equipment. The investment is projected to generate 23,000,000 the first year, 26,000,000 the second year and 30,000,000 the 3rd year. After the first 3 years, sales are projected to increase 10%/yr for the remaining 2 years.
The equipment will be disposed of after year 5 and has a residual value of 10,000,000. The equipment is in the 3 yr recovery period class for depreciation - MACRS.
Cost of goods sold is forecast to be 8,000,000 in the 1st year, 14,000,000 in the 2nd year, and increase at a rate of 9%/yr for the remaining 3 years.
Fixed operating expenses are 1,000,000 per year. Assume a 40% tax rate. Year-end net working capital is shown below:
Net Working Capital: 0 -$500,000; 1-$700,000; 2-$800,000; 3-$800,000; 4-$500,000; 5-$0
1) Calculate the free cash flows for periods 0 - 5
2) Calculate the net present value for a 12% cost of capital
3) Calculate the internal rate of return
4) Calculate the sensitivity of the investment to a change in the cost of capital (as low as 8% or as high as 16%)
Should the $40,000,000 investment be made? Why or why not?