Case Scenario:
Project Evaluation Suppose you have been hired as a financial consultant to Defense Electronics, Inc. (DEI), a large, publicly traded firm that is the market share leader in radar detection systems (RDSs). The company is looking at setting up a manufacturing plant overseas to produce a new line of RDSs. This will be a seven-year project. The company bought some land three years ago for $8 million in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. The land was appraised last week for $10.2 million. In five years the land will probably be worth the same amount. The company wants to build its new manufacturing plant on this land; the plant will cost $30 million to build. DEI's tax rate is 35 percent. The project requires $900,000 in initial net working capital investment to get operational. RDS's cost of capital is 13%
The manufacturing plant has an eight-year tax life, and DEI uses straight-line depreciation. At the end of the project (that is, the end of Year 7), the plant can be scrapped for $5 million.
The company will incur $400,000 in annual fixed costs. The plan is to manufacture 17,000 RDSs per year and sell them at $10,000 per machine; the variable production costs are $9,000 per RDS.
Q1. What are the project's annual operating cash flows?
Q2. Draw a time line depicting all projects cash flows. Indicate cash outflows with (brackets).
Q3. What is the project's IRR and NPV?
Q4. What level of sales (in units) must RDS to achieve an IRR of 15%?