Mills Mining Corporation, a firm in the 35 percent marginal tax bracket with a 12% percent required rate of return or cost of capital, is considering a new project. The project involves the introduction of a new product. Because the product is considered to be a “fad”, the project will be operational for only the next five years.
· The project requires an initial capital investment of $660,000. Shipping and installation will cost an additional $30,000.
· The capital investment will be depreciated using a 5-year MACRS schedule. The depreciation schedule is as follows: 20%; 32%; 19%; 12%; 11%; and 6%.
· If the project is undertaken, the company expects inventory and accounts receivable to increase by $90,000 and $45,000, respectively, and accounts payable to increase by $50,000.
· To project demand for this new product, the company has spent $250,000 in focus groups and pre-market testing.
· The project is expected to generate sales of 40,000 units in each the first and fifth years, 65,000 units in each the second and third years, and 55,000 units in the fourth year. The sales price per unit will be $12.
· Variable costs are expected to be $6.50 per unit. Additional operating costs (not including depreciation) will equal $52,500 a year.
· The firm expects to incur annual interest costs of $67,500.
The equipment is expected to have a salvage value (before-tax) of $30,000.
a. What are the cash flows associated with the project for each year?
b. What is the NPV of the project?
c. What is the internal rate of return on the project?
d. What is the regular payback period for the project?
e. Would you accept the project? Why or why not?