XYZ Aeronautics Corp. ("XYZ") manufactures landing gear for corporate aircraft. The company is evaluating the expansion of its manufacturing plant to enable it to take on a new customer segment for the next 5 years. Last year, the company spent $125,000 to do marketing research analysis to estimate market demand for new customer segments. The current expansion scenario would have total construction costs of $1.35 million and it would take about 50 days to complete (i.e., essentially up-front). ABC would also put in $662 thousand of new machinery and equipment. Inventory (raw materials, work-in-process, finished goods) investment needed for the expansion to get started would be $387 thousand. Except for the inventory investment, the total upfront investment can be depreciated using the straight-line method over four years. The company expects to incur $213 thousand in incremental annual interest expense, and the company expects it could increase annual dividends $0.12 per share (there are 1,200,000 shares outstanding). Incremental sales for this project are based on forecast demand of 61 units in the first year, 73 units in the second year, 87 units in the third year, 91 units in the fourth year, and 39 units in the fifth year, with an average selling price of $53,500 per unit. Cost of goods sold is estimated to be 64% of total sales each year, and incremental fixed costs are estimated to be $230,000 per year. At the end of the project's estimated life, the company estimates it could sell the purchased machinery and equipment for $250,000 and the expected the book value for these items would be zero. Also at the end of the project, $150,000 of inventory could be liquidated at its original cost (with no income tax effect). The company's income tax rate is expected to be 36% for ordinary income and 21% for capital gains income. If XYZ does this project, it will immediately sell some existing surplus equipment for a price of $375,000 which has a current book value of $180,000 and which has future depreciation of $60,000 per year for the next three years. XYZ's weighted average cost of capital is 12%, so it believes this project should earn at least a 14% average annual return.
1. What is the upfront total after-tax cash costs for this proposed project?
2. What are the Total Annual Free Cash Flows for Year 1? Year 2? Year 3?
3. What is the Total After-Tax Operating Cash Flow for Year 5 (exclude Terminal Year-specific
items)?
4. What is Terminal Year-specific Cash Flow (i.e., After-Tax Salvage Value excluding the Annual
Operating Cash Flow portion)? Show your work in appropriate detail.
5. Is(Are) there any irrelevant cash flow(s) mentioned in this problem? If so, what is(are) it(they)?
6. Are there any sunk costs for this project? If so, what are they?
7. Are there any opportunity costs for this project? If so, what are they?
8. What is the Net Present Value for this project proposal?
9. What is the Internal Rate of Return for this project proposal?
10. Would this project be a good investment? Why?