A company with profitable ongoing operations is considering a major product. The company has completed extensive research
Question:
A company with profitable ongoing operations is considering a major product. The company has completed extensive research and development testing on a new product at a cost of $150,000 and is now considering whether to proceed with production or not. If the company goes ahead with the project, the company will be required to invest $600,000 in new machinery. This can be placed for tax purposes in a CCA pool with a rate of 30% It is expected that the project will generate incremental revenues of $300,000 per year for each of the 5 years of the project and the incremental expenses of $50,000 per year for each of the 5 years of the project. It is anticipated that after 5 years the project will end, and the equipment will be sold to a competitor for $75,000. The company has many such pieces of equipment in apool with a large UCC.
• The company also anticipates that it will have to maintain its working capital requirements above its regular levels as follows:
• Year 0: $50,000; Year 1: $80,000; Year 2: $80,000; Year 3: $80,000; Year 4: $80,000. It is further anticipated that at the end of the fifth year, working capital requirements will return to pre-project levels.
• As additional complication of the project is that it is expected to cause a labour shortage at the company’s other plants. This will result in additional overtime costs estimated to be $20,000 per year for each of the five years of the project.
• The company pays income taxes at a rate of 40% and has deemed that the discount rate appropriate for the project is 10%.