1) Wacky Widgets, Incorporated is considering a new three-year expansion project to make new Widgets. It requires an initial fixed investment of $2.7 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which it will be sold for $50,000 to a scrapyard. The fixed asset will take 2 years to install, so subsequent sales increases will occur in years 2 -4.
The project is estimated to generate $2,800,000 in annual sales, with variable costs of 40 percent. There are no fixed costs, and working capital requirements are 5% of annual revenues. The tax rate is 35 percent and the required rate of return is 15 percent. The risk-free rate is 9 percent. Your firm requires a payback period of 3 years to approve a project.
The Widget produced by this product will often go to the same customers as the Bidget,another product produced by Wacky Widgets. They will often be shipped in the same package as another product the firm produces. It will not reduce the overhead on producing Widgets, but it will reduce the cost of shipping Bidgets by $20,000 per year in years 2 -4.
a-Construct a full pro-forma statement for this project’s projected incremental cash flows.
b-What is the payback period? Based on this decision rule, should you do the project?
c-What is the discounted payback period? Based on this decision rule, should you do the project?
d-What is the NPV? Based on this decision rule, should you do the project?
e-What is the IRR? Based on this decision rule, should you do the project?
f-What is the profitability index? Based on this decision rule, should you do the project?
g-Should you approve the project? What decision rule are you using to make your final decision?