Question

Project 2

As the financial advisor to Cindy Manufacturing you are evaluating the following new investment in a project: -

• The project has a useful life of 12 years.

• Land costs $6m and is estimated to have a resale value of $10m at the completion of the project.

• Buildings cost $5m, with allowable depreciation of 10% pa reducing balance and a salvage value of $0.9m.

• Equipment costs $4m, with allowable depreciation of 20% pa reducing balance and a salvage value of $0.5m. An investment allowance of 20% of the equipment cost is available.

• Revenues are expected to be $7m in year one and rise at 5% pa.

• Cash expenses are estimated at $3m in year one and rise at 3% pa.

• The new product will be charged $400,000 of allocated head office administration costs each year even though head office will not actually incur any extra costs to manage the project.

• An amount of $100,000 has been spent on a feasibility study for the new project.

• The project is to be partially financed with a loan of $7.5m to be repaid annually with equal instalments at a rate of 4% pa over 12 years.

• Except for initial outlays, assume cash flows occur at the end of each year.

• The tax rate is 30% and is payable in the year in which profit is earned.

• The after-tax required return for the project is 8% pa.

A) Calculate the NPV. Is the project acceptable? Why or why not?

B) Conduct a sensitivity analysis showing how sensitive the project is to revenues, the resale value of the land and to the required rate of return. Explain your results.

Answer 1

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