ABC corporation has existing property and equipment that is
not in use. The company is considering the use of this property and
equipment. One option is to use the property and equipment to
produce a new product. Estimates for demand of this product are
30,000 units annually for the first 5 years and 20,000 units
annually for the following 6 years. Beyond that, the product is
considered to be obsolete and production will cease. Price and
variable costs would be $100 and $65, respectively. Fixed costs
would be $225,000 per year. If they take this option, they must buy
additional equipment for a total of $2 million. This equipment will
be depreciated straight-line over a 15 year period of time. When
the project is ended (in 11 years), it is expected they will be
able to sell the equipment for $130,000. This option also requires
an initial net working capital investment of $400,000. This initial
NWC investment can be reduced to $300,000 when sales drop (i.e.
from year 5 to year 6). The net working capital will be fully
recouped at the end of the project. This project is riskier than
the average project for the company. Management has determined that
the appropriate discount rate to use will be the company WACC + 3%
to account for the additional risk.
11. What is this project’s OCF for years 1-5?
12. What is this project’s OCF for years 6-11?
13. What is this project’s TCF for year 0?
14. What is this project’s TCF for years 1-5?
15. What is this project’s TCF for year 6?
16. What is this project’s TCF for years 7-10?
17. What is this project’s TCF for year 11?
18. What is the project’s NPV?
19. What is the project’s break-even price?
20. Does this company have the internal resources to finance
this project?
a. Yes
b. No