The Shome Corporation, a firm in the 36% marginal tax bracket with a required rate of return or discount rate of 16%, is considering a new project. This project involves the introduction of a new product. This project is expected to last 5 years and then, because this is somewhat of a fad project, it will be terminated. Given the following information determine the net cash flows associated with the project, the projects net present value, the profitability index, and the internal rate of return. Apply the appropriate decision criteria.
Data Table
Cost of new plant and equipment: $7,200,000
Shipping and Installation Costs: $80,000
Unit Sales
Year Units Sold
1 60,000
2 90,000
3 110,000
4 50,000
5 50,000
Sales prices per unit: $220/unit in years 1 through 4, $170/unit in year 5
Variable Cost per unit: $110/unit
Annual Fixed costs: $280,000
Working Capital Requirements: There will be an initial working capital requirement of $90,000 to get production started. For each year, the total investment in net working capital will be equal to 9 percent of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5.
The Depreciation method: Use the simplified straight line method over 5 years. It is assumed that the plant and equipment will have no salvage value after 5 years.
a) Determine the free cash flows associated with the project
The FCP in year 0 is at
The FCP in year 1 is at
The FCP in year 2 is at
The FCP in year 3 is at
The FCP in year 4 is at
The FCP in year 5 is at
b) The net present value (NPV) of the project is
c) The profitability index (PI) of the project is
d) The internal rate of return (IRR) of the project is