Problem:
ABC Corporation is considering an expansion project. To date they have spent $150,000 investigating the viability of the project and have decided to proceed. The proposed project will cost $1,500,000 in addition to the $150,000 that was spent on the feasibility study. The project will be depreciated over a 3 year MACRS class life.
MACRS
Depreciation
Year Rates
1 0.33
2 0.45
3 0.15
4 0.07
If the project is undertaken the company will need to increase its inventories by $500,000, and its accounts payable will rise by $200,000. The company will realize an additional $1,500,000 in sales over each of the next four years. The company's operating costs (not including depreciation) will increase by $750,000 a year. The company's tax rate is 34%. At t = 3, the project's economic life is complete, but it will have a salvage value (before-tax) of $150,000 after three years. The project's WACC is 12%.
a) What is the project's net present value (NPV)? What is the IRR?
b) Write a short memo to management explaining your analysis and making a recommendation. Should the project be accepted? Why or why not? (i.e. Explain what your numerical answer means.)