ABC Corp is producing at full capacity, George has decided to have Craig examine the feasibility of a new manufacturing plant. This expansion would represent a major capital outlay for the company. A preliminary analysis of the project has been conducted at a cost of $1.2 million. This analysis determined that the new plant will require an immediate outlay of $60 million and an additional outlay of $30 million in one year. The company has received a special tax dispensation that will allow the building and equipment to be depreciated on a 20-year MACRS schedule.
Because of the time necessary to build the new plant, no sales will be possible for the next year. Two years from now, the company will have partial-year sales of $19 million. Sales in the following four years will be $29 million, $37 million, $41 million, and $45 million. Because the new plant will be more efficient than ABC current manufacturing facilities, variable costs are expected to be 60 percent of sales, and fixed costs will be $2 million per year. The new plant will also require net working capital amounting to 8 percent of sales for the next year.
Craig realizes that sales from the new plant will continue into the indefinite future. Because of this, he believes the cash flows after Year 5 will continue to grow at 4 percent indefinitely. The company's tax rate is 40 percent and the required return is 11 percent.
George would like Craig to analyze the financial viability of the new plant and calculate the profitability index, NPV, and IRR. Also, George has instructed Craig to disregard the value of the land that the new plant will require. ABC already owns it, and, as a practical matter, it will simply go unused indefinitely. He has asked Craig to discuss this issue in his report.