Problem
Instead of purchasing luxury spa products from Crabtree & Evelyn or Neutrogena, Matthew wants to develop his own line of luxury spa products, Illisia, for use in his Athenia hotel in the heart of Ottawa. You are asked to evaluate the viability of Illisia. Necessary equipment to package Illisia will cost $5 million, including installation costs in the Athenia hotel. Illisia will also require an initial investment of $1 million in net working capital and will generate increased pre-tax revenues that are $3 million for the first year. The increased revenues include sales of the Illisia line in Athenia hotel stores and the expected increased occupancy when luxury tourists and politicians stay at the Athenia just to enjoy Illisia spa products. Then the pre-tax revenues will grow at an annual rate of 2.5 percent for the next 14 years as business, leisure and political luxury travel (paid by taxpayers) takes off with the end of the pandemic. Environmentally friendly dry products will significantly reduce Illisia's demand in 15 years, and luxury spa products will be replaced with a cancer-free "dry" line, like dry shampoo, leave-in conditioner and dry soap that no longer cause cancer. The pre-tax operating costs will be $2 million/year for the 15 years, mostly to purchase quality spa products produced at a factory in Cornwall to be repackaged as "Illisia". The salvage value of Illisia's equipment will be $1 million at the end of year 15.
The initial equipment purchased falls into a CCA Asset Class 8 at a rate of 20 percent. The corporate tax rate is 40 percent and the cost of capital is 15 percent. Assume the initial working capital investment will be made at the time of the purchase of the equipment and recovered or returned at the end of year 15. For simplicity, all cash flows for a given year occur at the end of the year.
• What are the NPV and IRR of the Illisia product line doing the calculations by hand (with a calculator)?