Response to the following problem:
ABC Co is evaluating a capital project for the production of a high definition portable television. The proposal will require a construction contractor to prepare the necessary facilities by the end of December, 2017, at a total cost of $250,000. Payment for construction costs will be made at the end of December 2017. In addition to construction costs, an additional $50,000 in cash will be made available for working capital for this project.
ABC anticipates that the television has a limited market life, and there is a possibility that by 2024 the unit will be removed from production. Therefore, the proposal specifies production will cease by the end of December, 2023, at which time the investment in working capital will be released. In addition, it is estimated that the production capacity can be liquidated as salvage for $30,000.
The projected cash inflows from operations are as follows:
2018................................ $100,000
2019............................... $100,000
2020............................... $100,000
2021............................... $40,000
2022............................... $40,000
2023............................... $40,000
ABC uses a discount rate of 16% for this project. All cash flows occur at the end of the year.
Required:
Evaluate this project using the NPV method. Should ABC accept or reject this project proposal?
Assume that the proposal is accepted and construction has begun. Construction-related issues delay completion of the project as scheduled. Completion is delayed for one calendar year, to December 2018. Payment for construction of $200,000 is made at the end of December, 2017. Project completion will require an additional $100,000 of project cost to be paid at the end of December, 2018. The plant would then start production January, 2019. Due to the change in cost structure, a new cash inflow prediction is as follows:
2019............................... $120,000
2020............................... $100,000
2021............................... $40,000
2022 ............................... $40,000
2023............................... $40,000
The release of working capital under this revised scenario is made available December 2018. No other changes in the project's financials are expected.
Use the NPV method to evaluate the project under the revised scenario. Should the project have been accepted in 2017 under this scenario.
Prepare a memo highlighting the NPV evaluation. Include in the memo other factors that ABC should take into consideration regarding this project.