Calliope Company is considering an investment of $60 million in plant and machinery. The property and machinery will be depreciated to a zero book value based on MACRS. It is in the 3-year property class. The firm has a 4-year planning horizon. The machinery will be sold at the end of 4 years for $5 million (there is no horizon value). The investment is expected to produce sales of $45 million in year 1 and $80 million in year 2 and to grow by 6% each year for the remaining two years. Cost of goods sold is expected to be 40% of sales and does not include the depreciation expense. Fixed operating costs are $4 million in year 1 and increase by 3% each year for the remaining 3 years. The tax rate is 40%. Net operating working capital is 2% of next year’s sales.
Calliope has a target debt ratio (debt/value) of .30. The cost of debt is 10% and the cost of equity is 25%. Use the weighted average cost of capital (WACC) to find the net present value (NPV). Should Calliope invest? Why or why not?