Question

Suppose ABC firm is considering an investment that would extend the life of one of its facilities for 4 years. The project would require upfront costs of $8.93M plus $25.59M investment in equipment. The equipment will be obsolete in (N+2) years and will be depreciated via straight-line over that period (Assume that the equipment can't be sold). During the next 4 years, ABC expects annual sales of 72M per year from this facility. Material costs and operating expenses are expected to total 40M and 7.91M, respectively, per year. ABC expects no net working capital requirements for the project, and it pays a tax rate of 39%. ABC has 74% of Equity and the remaining is in Debt. If the Cost of Equity and Debt are 14.13% and 5.96% respectively, Should they take the project? (Evaluate the project only for 4 years)

Answer 1

The cost of Capital is calculated to be 11.401% using the weighted average cost of capital.

Using the cost of debt after tax is 3.6356% and Cost of equity of 14.13% and applying the weights given.

The depreciation per year amounts to $8.63M

Years	1	2	3	4
	in m$
Sales	72.00	72.00	72.00	72.00
Materials	40.00	40.00	40.00	40.00
Op Costs	7.91	7.91	7.91	7.91
Dep	8.63	8.63	8.63	8.63
Profit	15.46	15.46	15.46	15.46
Tax	6.03	6.03	6.03	6.03
PAT	9.43	9.43	9.43	9.43
Cash Flow	18.06	18.06	18.06	18.06
Discounting factor	0.897654	0.805783	0.723315	0.649286737
PV of CF	16.21218	14.55293	13.0635	11.72650805
NPV	21.03511

SInce the NPV of the project is positive, the project is acceptable.