Question 1) Project Evaluation
Aguilera Acoustics (AAI), Inc., projects unit sales for a new seven-octave voice emulation implant as follows:
Year Unit Sales
1 $85,000
2 $98,000
3 $106,000
4 $114,000
5 $93,000
Production of the implants will require $1,500,000 in net working capital to start and additional net working capital investments each year equal to 15 percent of the projected sales increase for the following year. Total fixed costs are $900,000 per year, variable production costs are $240 per unit and the units are priced at $325 each. The equipment needed to begin production has an installed cost of $21,000,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as 7-year MACRS property. In five years, this equipment can be sold for about 20 percent of its acquisition cost. AAI is in the 35 percent marginal tax bracket and has a required rate of return on all of its projects of 18 percent. Based on these preliminary project estimates, what's your recommendation? Hint: use NPV and IRR as decision criteria.
Question 2) Project Analysis Evaluation
Dickinson Brothers Inc. is considering investing in a machine to produce key boards. The price of the machine will be $400,000 and its economic life is 5 years. The machine will be fully depreciated by the straight-line method. The machine will produce 10,000 key boards each year. The price of each key board will be $40 in the first year and will increase by 5% per year. The production cost per key board will be $20 in the first year and will increase in the first year and will increase by 10% per year. The project will have an annual fixed cost of $50,000 and require an immediate investment of $25,000 in net working capital. The corporate tax rate for the company is 34%. If the appropriate discount rate is 15%, would you recommend that the project be implemented? Why is it important to capture the inflation effects in project analysis?