Problem:
A company is considering adding a new line of products. The production line would be set up in its main plant. The machinery's invoice price would be $200,000.
Another $10,000 in shipping charges would be incurred and it would cost an additional $30,000 to install the equipment. Further the firm's inventories would have to be increased by $25,000 to handle the new line, but its accounts payable would rise by $5,000. The machinery has an economic life of 4 years, and the company expects to depreciate the asset to zero on a straight line basis over 4 years. Its expected salvage value is $25,000.
The new line would generate $125,000 in incremental revenues,(after expenses, but before taxes and excluding depreciation) in each of the next 4 years. The firm spent $100,000 last year to rehabilitate the production line site. The space envisaged for the new project could be leased out to an associated corporation for $25,000 (pre-tax) a year. The new product line is expected to decreases sales of the firms other lines by $10,000 (pre-tax) in the first year, to rise by 20% in each of the second, third and fourth year of the project. Firm's tax rate is 34%
Q1. Define the incremental cash-flows for the project on a year by year basis
Q2. Given a discount rate of 12%, calculate the projects NPV, IRR, Profitability index, payback period and average accounting return.
Q3. Does the payback method agree with the NPV? Explain.