Your employer is considering a capital project. The project involves installing a new manufacturing line that will cost $4 million. The line will be installed area of the factory that was refurbished in 2008 at a cost of $750,000. The line will be depreciated on a straight-line basis over five years, to a salvage value of $0. If implemented, the project will cause an immediate increase in Inventory of $200,000. It will also cause immediate increases in Accounts Receivable of $300,000, Accounts Payable of $150,000, and Long-Term Debt of $3 million.
If implemented, the project is expected to generate annual sales of $3,500,000 during each of the next five years. In addition, it is expected to generate combined COGS and SG&A expense of $2 million per year. At the end of the project’s five-year life, production will cease, and the manufacturing line will be sold for an estimated $100,000. At that time, Inventory, Accounts
Receivable and Accounts Payable will return to their pre-project levels.
Capital’s marginal and average tax rate is 35%. The firm has 1 million shares of common stock outstanding. The firm requires a 12% rate of return on capital projects.
Prepare a discounted cash flow analysis to determine whether your employer should implement this capital project. Your analysis should provide answers to each of the following questions.
1. What is the project’s initial investment?
2. What are the future annual incremental operating cash flows?
3. What is the terminal cash flow?
4. What is the NPV?
5. What is the IRR?
6. Should Capital implement the project? Why or why not?
7. If Capital implements the project, what will be the impact on the stock price?
Would greatly appreciate the inclusion of specific calculations, on Excel or otherwise