Question

We assume that the company you selected is considering a new project. The project has 8 years’ life. This project requires initial investment of $330 million to purchase equipment, and $25 million for shipping & installation fee. The fixed assets fall in the 7-year MACRS class. The number of units of the new product expected to be sold in the first year is 1,350,000 and the expected annual growth rate is 5%. The sales price is $250 per unit and the variable cost is $182 per unit in the first year, but they should be adjusted accordingly based on the estimated annualized inflation rate of 2%. The required net operating working capital (NOWC) is 7.5% of sales. Use the corporate tax rate obtained in Step (4) for the project. The project is assumed to have the same risk as the corporation, so you should use the WACC you obtained from prior steps as the discount rate. Note: you may revise the partial model in the file Ch11 P18 Build a Model.xls on the website of the textbook (also posted in this final project learning module in Blackboard) for capital budgeting analysis, but you are NOT required to strictly follow the partial model. Actually, you are encouraged to build a better model by yourself.

Corporate Tax Rate=10.18%

WACC=6.54%

Answer 1

Total cost of equipment = purchase cost + installation

Operating cash flow (OCF) each year = income after tax + depreciation - change in NOWC

In year 8, the entire NOWC is recovered, and hence the change in NOWC is negative

NPV and IRR are calculated using NPV and IRR functions in Excel

NPV is $294,257,491

IRR is 22.33%

The project should be accepted as the NPV is positive and the IRR is higher than the WACC