Question

Equipment:

The project involves the purchase of a new machine. The machine costs $500,000 is depreciable over 5 years. The machine requires a new building which would cost another $250,000 (we assume that the construction of the building takes place at t=0). The building is also depreciable over 5 years. The building will occupy a field bought 2 years ago for $200,000. The best other use for the field is as a parking lot for employees. The post-tax present value of employee parking for the life of the project is $65,000. In spite of the fact that the building and the machine will be fully depreciated, the company is expected to sell the machine and the building to a competitor for a total salvage value of $200,000 after the 5 year project is complete.

Project Operation:

At the beginning of year 1, the firm will need to increase its noncash working capital by $600,000, fully recovered at the end of the project in five years. The expected quantities of the new product sold to customers would be: Year 1 (ie: at t=1) 400 units; Year 2: 400 units; Year 3: 400 units; Year 4 and 5: 700 units. The sale price of the product is expected to be $1,000 during the first three years and then to grow by 10% each year. The “per unit cost” is expected to be $300 for the duration of the project.

      Other:

      The tax rate is 35%. The discount rate is 10.5%.

Answer 1